POSTWAR ECONOMIC STUDIES 

No. 5, September 1946 

PRIVATE CAPITAL 

REQUIREMENTS 

FREDERICK C. DIRKS 

ERNEST J. HOPKINS 

BOARD OF GOVERNORS 

OF THE FEDERAL RESERVE SYSTEM 

WASHINGTON 

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Published September 1946 

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CONTENTS 

PAGE 

PREFACE Inside Front Cover 

POSTWAR CAPITAL FORMATION AND ITS FINANCING IN 

MANUFACTURING AND MINING INDUSTRIES 

FREDERICK C. DIRKS 1 

Postwar Pattern of Industrial Output 2 

Gross National Product in 1948 4 

Relation of Industrial Output to Gross National Product 5 

Pattern of Industrial Activity 6 

Plant Capacity and Capital Expenditures 8 

Need for New Plant Facilities, 1941-47 9 

Actual Plant Expansion, 1941-44 12 

Plant Expansion in 1941-44 Usable after War 14 

Prospective Capital Expenditures, 1945 to Mid-1948 15 

Inventories and Other Working Capital Needs 17 

Projected Dollar Sales in 1948 17 

Outlook for Inventory Expansion 19 

Need for Liquid Assets 21 

Net Extension of Trade Credit and Other Working Capital Items. 24 

Financing Postwar Needs 25 

Financial Adjustments of the Transition 25 

Internal Sources of Funds 28 

Indicated Need for External Financing 33 

Limitations of Analysis and Some General Conclusions 35 

LONG-TERM NEEDS OF SMALL BUSINESS 

ERNEST J. HOPKINS 37 

The Meaning of "Small Business" 40 

Attempted Statistical Definitions 40 

Qualifications of the Statistics 41 

Description of the Term 42 

Economic Measurements and Characteristics 43 

The Small Business Population 43 

Number and Distribution 43 

Numerical Persistence of Small Business 45 

Employment in Small Business 46 

The Place of Small Business in Production 48 

Retail Trade 49 

Service 50 

iii 

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iv CONTENTS 

PAGE 

Long-Term Needs of Small Business {Cont.) 

Economic Measurements and Characteristics {Cont.) 

The Place of Small Business in Production {Cont.) 

Construction 50 

Manufacturing 51 

Other Activities 52 

Internal Characteristics of Small Business 53 

High Sales-Capital Ratio 53 

The Mechanical Equipment of Small Business 55 

Type of Efficiency of Small Business 55 

Inferences to a Program of Aids 56 

Nonfinancial Problems of Small Business 56 

Need for Technological Information 57 

Need for General Management Advice 58 

Problems of Imperfect Competition 59 

Problems of Unilateral Bargaining 60 

Problems of Inadequate Information on the Small Business Area.. 60 

The Department of Commerce Office of Small Business 60 

Internal Financing and Taxation 62 

Problems of External Financing 65 

Historical Basis of Problem 66 

Central Principle of Solution 69 

Application to Working Capital Credits 70 

Application to Long-Term Capital Needs 72 

Obstacles to the Term Loan 73 

Central Guaranteeing of Term Loans 74 

Some General Considerations 75 

Summary and Conclusion 76 

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POSTWAR CAPITAL FORMATION AND ITS FINANCING 

IN MANUFACTURING AND MINING INDUSTRIES1 

by 

FREDERICK C. DIRKS 

Formerly of Division of Research and Statistics, Board of Governors 

Business policies in expanding inventories and plant and equipment, 

and in spending or retaining liquid balances accumulated during the 

war, will be among the important factors determining postwar economic 

trends. Reluctance of business concerns in general to expand the basis of 

operations would react unfavorably on national employment; on the other 

hand, efforts to expand very rapidly, at a time when demand for goods by 

domestic consumers will be supplemented by exceptionally large demand 

from foreign sources, would contribute to existing inflationary pressures. 

These pressures would be intensified if prospective business expansion 

should be financed largely by bank credit, either directly through loans 

or indirectly through a reduction in business holdings of Government 

securities, rather than by attracting private investment funds. 

In trying to gauge possible problems connected with postwar business 

finance it is helpful to review the available statistics for evidence, first as 

to the need for new inventories and new plant and equipment, and second 

as to the need for new financing. With the close of the war, there has been 

considerable uncertainty over the extent to which wartime inventories 

and enlarged war plants may have obviated the need for further expansion, and similar uncertainty whether funds will be needed to supplement 

the wartime accumulations of liquid business balances. Since these uncertainties are greatest in manufacturing and mining industries, where 

war production and war profits have been concentrated, the present paper 

will deal with the situation in these industries. 

In order to consider developments peculiar to the war period, the analysis throughout distinguishes between industries in which war production 

was especially concentrated and "all other" industries. Two broad industry groups, "metals and products" and "petroleum, chemicals, and 

rubber" represent the war industries and the residual group may be 

characterized as "non-war" industries although many companies had 

Government contracts. 

^his paper, as well as the other paper in this pamphlet, was prepared under the general 

supervision of Miss Susan S. Burr, Chief of the Capital Markets Section of the Board's Division 

of Research and Statistics. 

1 

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2 PRIVATE CAPITAL REQUIREMENTS 

Tentatively, it appears that large as the wartime plant expansion has 

been, there is still room for substantial private capital expenditures before a reasonably high level of peacetime employment and production 

can be reached. Whether much new financing will be required will depend 

partly on price-cost relationships and their effect on profits, and partly 

on the rapidity of the postwar expansion. If profits should rise to the unprecedently high levels predicted by some, and if progress toward full 

employment should come gradually, little outside financing will be needed. 

If, on the other hand, price-cost relationships should be such as to keep 

profits below (say) the 1941 level, the moderate amount of internal funds 

arising from business operations will probably fall far short of the amounts 

required for a rapid expansion of production, and considerable outside 

financing will be entailed. 

Quantitative appraisal of the prospects must be greatly qualified by 

the fact that existing internal funds will probably not be distributed 

among individual concerns in accordance with their needs, so that a 

superfluity of funds among some companies will be accompanied by a 

deficiency among others. The amount of outside financing actually needed 

will therefore be much greater than can be gauged from over-all data. 

Already (early in 1946) the importance of this factor has been demonstrated in the considerable growth of new security financing during late 

1944 and 1945, and in the more recent expansion of bank loans. 

How large a volume of new financing is likely can only be guessed at 

present. While tentative conclusions can be drawn from the available statistics under certain hypotheses, the presence of statistically non-measurable factors limits practical application of the conclusions. Thus, in the 

present instance, not very much can be said in advance about the rate of 

technological innovation and the reaction of businessmen to Government 

policies affecting prices and wage costs, although these factors may affect 

very appreciably the magnitudes of business outlays and financing. 

POSTWAR PATTERN OF INDUSTRIAL OUTPUT 

Underlying any appraisal of postwar needs for plant and equipment, 

inventories, and other working capital is the question how much market 

demand is likely to be encountered. For many manufacturing and mining 

industries (as well as for public utilities, transportation, trade, and service 

industries), prospective market demand corresponds to prospective consumer expenditures. For a few industries, chiefly within the metal 

products group, market demand will depend upon the expansion in plant 

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MANUFACTURING AND MINING INDUSTRIES 3 

capacity required in industries serving consumers and in the metal 

products industries themselves. 

The relationship between activity in consumer goods industries and 

in the metal products industries is evidently not a linear one at various 

levels of national production; metal products industries are subject to 

much wider swings than consumer goods industries. Moreover, the relationship is not such that future patterns of production can easily be 

inferred by looking at the patterns which obtained in the past at various 

levels of national output. 

Activity in the metal products industries involves intricate relationships with such factors as deferred replacement, technological obsolescence, long-range expansion programs, and the like; and the 

conjuncture of these factors in any particular year is likely to be peculiar 

to that year. To a lesser degree the same situation obtains in industries 

producing consumer durable and semi-durable goods. Thus a thorough 

analysis of prospective patterns of industrial activity would require a 

great number of studies of consumer holdings of durable goods and industry holdings of plant capacity, with year-by-year projections showing 

the retirement of existing equipment and purchase of new equipment, 

and a final integration of the consumer and business segments of the 

economy, and of the manufacturing and nonmanufacturing segments of 

business. 

Such a comprehensive analysis of the factors determining future market 

demand and patterns of industrial output has never been made. Moreover, it would be pretentious to attempt it at this time as a basis for 

"scientific" projections because very important elements still have to be 

treated by arbitrary assumption. It is fairly certain that the over-all 

level of national product will expand to new peacetime records as a result 

of large backlogs of deferred demand, buttressed with unprecedented 

reservoirs of liquid assets among consumers. But the amount of consumer 

expenditures relative to current consumer incomes, and also the amount 

to be spent for services in contrast to goods, and for nondurable in contrast to durable goods, are all matters of unenlightened conjecture. These 

uncertainties are mentioned to emphasize the tenuousness of projections 

concerning postwar business expansion, and to serve as a reminder that 

any one set of such projections is at best illustrative of only one of many 

possible patterns of economic activity. 

In view of these considerations a fairly simple procedure will be followed 

here of positing a level of gross national product and then outlining a 

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4 PRIVATE CAPITAL REQUIREMENTS 

pattern of industrial activity on the basis of past relationships with gross 

national product. 

Gross National Product in 1948. Viewed in the abstract, the question 

"what level of demand and when" is an open-end question that permits 

a considerable range of views depending on the time periods with which 

the questioner is most concerned. Over the immediate months ahead, 

there is evidently so large a backlog of consumer demand that inflexibility of supply is probably the chief factor limiting expansion; in evaluating the outlook for such a period, the timing of various factors likely to 

retard or to accelerate production would be of first importance. 

In this paper the prospects for expansion of industrial capacity following the war, and for its financing, will be explored for the intermediate 

period to mid-1948. For the period as a whole the timing of minor factors 

affecting the rate of advance may reasonably be ignored and the assumption made that the wartime backlog of consumer demand, plus demand 

for producers' equipment both in this country and abroad, will provide 

an impetus for rapidly expanding industrial production and national 

income, approaching a condition of full employment. 

For present illustrative purposes, it will not matter particularly whether 

the level of industrial output selected for exposition is actually the maximum obtainable in a full employment economy, or whether it is a little 

above or a little below; it will be sufficient that the level should be reasonably likely of attainment in the next period of active business advance. 

The annual rate of gross national product used in these calculations for 

June 1948 (and for the year as a whole) will be 225 billion dollars in current 

prices, or about 201 billion in 1945 prices. 

The assumption in 1945 prices is consistent with postwar trends in 

gross national product recently calculated by several analysts.2 Already 

(early in 1946) it is apparent that the 1946 price average will be considerably above 1945; if by 1948 prices should be 12 per cent above 1945, the 

current value of the projected gross national product would be 225 billion 

2

Four of these estimates, after being adjusted by Everett E. Hagen to a common assumption of 60 million persons in the labor force in 1950 and working hours the same as in 1940, 

ranged from 202 to 208 billion dollars in terms of 1943 prices. See Review of Economic Statistics, 

May 1945, pp. 47 and 50. In Dun's Review for May 1945, Edwin George has also compared 

various estimates of gross national product at full employment, arriving at somewhat lower 

figures than Hagen's. If on this basis a figure of 205 billion is assumed for 1950, and adjusted to 

1948 by deduction of an average output of $4,000 for one million fewer persons in the labor 

force and of an allowance of 5 per cent for lower productivity, the result is 191 billion dollars. 

Since this figure is specified in terms of 1943 prices, an allowance for the roughly 5 per cent 

increase in prices to 1945 would bring the total to 201 billion. 

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MANUFACTURING AND MINING INDUSTRIES 5 

dollars. The price factor will be of major importance in increasing business 

requirements for working capital—that is, for inventories, customer 

credit, and liquid balances. It will also affect the expenditures needed to 

achieve any specified increase in physical plant capacity. 

Relation of Industrial Output to Gross National Product. Underlying 

the question of how much industrial capacity is likely to be needed after 

the war is the question of the demand for manufactured products. It seems 

quite possible that with the return to peace, the relative importance of 

manufacturing activity in the national economy may be less than it was 

during the war; that reattainment of recent wartime levels of gross national product and full employment may mean somewhat less employment 

in manufacturing, especially the metal producing industries, and more 

employment in nonmanufacturing lines, with a corresponding shift in 

the need for plant capacity. 

As regards aggregate industrial production, past relationships with 

gross national product provide only a rough basis for gauging future 

trends. Graphic comparisons of fluctuations in industrial production and 

in gross national product (adjusted to exclude price changes) from 1919 

to 1945 suggest that industrial output increased proportionately with 

gross national product from 1920 to 1929, and that 1937 and 1940 were 

on the line of relationship for this period. In contrast, however, the movements downward from 1929 to 1932, and upward from 1932 to 1937 and 

from 1938 to 1943, reflect relatively greater variations in industrial output 

than in gross national product.3 

How these past fluctuations are interpreted will affect very considerably 

the particular figures one may select for industrial output to accompany 

particular levels of gross national product. The analyst may, for example, accept as normal the proportionally greater movement of industrial output that prevailed over the major part of the past 25 years and 

decide that a high postwar level of gross national product would involve 

a level of industrial output not far different from the recent wartime experience. Alternatively the proportional movements from 1920 to 1929 

(1937 and 1940 were also in line with this relationship) might be taken 

as more relevant for the 1946-48 outlook. A third possible interpretation 

would involve reconciling the diverse relationships by assuming a cyclical 

3The comparison of indexes of industrial activity and of gross national product deflated for 

price movements is at best precarious owing to the possibility of appreciable trend in either 

series. For this reason the interpretation of historical data needs to be combined with a common-sense appraisal of the factors likely to shape the future. 

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6 PRIVATE CAPITAL REQUIREMENTS 

movement of industrial output that is proportionally greater than the 

movement of gross national product, coupled with a long-run trend 

toward expanding the nonindustrial part of the national economy. Statistically the latter would be expressed as a downward time trend in the 

relative importance of industrial activity.4 

Quite different results are obtained by applying these three alternative 

interpretations of the past to gauge industrial activity in the three postwar 

years under consideration. Application of the relationship of industrial 

activity to gross national product in 1919-29 and the two years 1937 

and 1940 to the assumed gross national product of 201 billion dollars 

would suggest a production index for 1948 of 204 (1935-39 average = 

100); projection of the more volatile movement of industrial production 

in the periods 1932-37 and 1938-43 would yield an index level of about 

244; the third approach, which combines the second with a long-run 

downward trend in the relative importance of industrial activity, would 

indicate an index of 205 to 230 depending on the weight given to wartime data. 

Pattern of Industrial Activity. In part the indeterminateness of the 

over-all correlation between industrial activity and gross national product 

stems from divergent movements of the component parts of industrial 

production. Another approach which takes account of such differences 

involves a general judgment as to the postwar trends by industry groups. 

Projections by this method are presented in the table on page 7. While 

the industry groups also conceal divergent movements among component 

industry subgroups, they permit the introduction of more qualitative 

factors than was the case for the over-all approach. 

During the expansion from 1933 to 1937 and again from 1938 to 1942, 

production in nondurable goods industries as a group increased about 

proportionately with gross national product. During the war, however, 

various segments of nondurable goods industries have exhibited con4

 A rough calculation indicates that the 1919-45 movements could be fairly well summarized 

by the equation 

T , , . . , L. (gross national product)1

*

5 

Industrial production = * „ ^ns, <n„, 10 (1.012) (year

-

1932) 

where industrial production represents the Federal Reserve index and gross national product is 

the series expressed in 1944 prices as published in Basic Facts on Employment and Production, 

(Report to the Committee on Banking and Currency, Senate Committee Print No. 4), Sept. 1, 

1945, p. 11. The equation reflects the more volatile movements of industrial production in 

relation to the gross national product, as well as a long-run downward trend of 1.2 per cent 

a year in their relationship. 

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siderable diversity. Output of the petroleum, chemicals, and rubber products group rose sharply to wartime peaks in 1943 and 1944 while food 

and textile products increased less sharply. Activity in other nondurable 

lines declined slightly in 1942 and 1943; by 1945 output had recovered 

but was still slightly below the 1941 level. 

The reactions of these different nondurable goods industries to wartime needs and restrictions are reflected in the projected levels of production in 1948 suggested in the accompanying table. Output of petroleum, 

PROJECTED LEVEL OF INDUSTRIAL PRODUCTION FOR 1948 

(Federal Reserve index of physical volume, 1935-39 average = 100) 

Industry group 

Total1 

Nondurable manufactures 

Food products 

Textiles and products 

Petroleum, chemical, and rubber 

products 

Other 

Durable manufactures1 

Iron and steel 

Nonferrous metals and products 

Machinery 

Transportation equipment 

Other 

Minerals 

Wartime peak 

Year 

1943 

1943 

1944 

1942 

1943 

1941 

1943 

1943 

1943 

1943 

1943 

1942 

1944 

Index 

239 

176 

152 

1 157 

319 

129 

360 

208 

267 

443 

735 

148 

140 

1945 

203 

166 

150 

146 

263 

128 

274 

183 

204 

343 

487 

131 

137 

1948 

208 

180 

155 

170 

250 

160 

272 

200 

230 

325 

400 

180 

140 

1

 Subtotals for durable manufactures and total include allowance for activity in Government arsenals and 

shipyards. 

chemicals, and rubber may fall considerably short of the 1943 peak, food 

products may be only slightly above their 1944 peak, while textiles and 

miscellaneous nondurables (leather, tobacco, beverages, paper, printing) 

may well rise considerably above previous highs. 

Activity in durable goods manufacturing has typically fluctuated more 

sharply cyclically than gross national product, while mineral production 

has varied more nearly in proportion to it. In conjunction with this 

cyclical behavior, output of the machinery, transportation equipment, 

and nonferrous metal industries also evidenced a long-run tendency to 

drift downward relative to gross national product, as compared with 

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8 PRIVATE CAPITAL REQUIREMENTS 

other manufacturing and nonmanufacturing industries. During the war 

output of nonferrous metals, machinery, and transportation equipment 

rose sharply to peaks in 1943 while steel and other durable lines showed 

little relative growth after the early defense expansion of 1940-41. 

Projections of durable goods industries on the basis of past relationships with gross national product are especially precarious in some groups 

because of new factors that were not present in either the wartime or the 

prewar situation. In such lines as nonferrous metals and aircraft, the war 

stimulus is likely to carry over in substantial part into civilian production, 

and in other fabricated lines, such as autos and railroad equipment, there 

exist large backlogs of deferred demand. 

The table shows the levels of activity that will be assumed to obtain in 

the individual industries in 1948. The figures for the several industrial 

groups add to an over-all industrial index of around 208 per cent of the 

1935-39 average. In relation to gross national product, this figure stands 

in about the same proportion as in 1941. 

While a level of 208 would be only slightly higher than the 203 recorded 

for 1945, it represents an altogether different situation in the composition 

of industrial production, involving a considerable decline in the Government component and nearly a doubling in the output available for civilian 

consumption. As will be explained later, it has been assumed in this connection that by 1948 Government industrial activity will have ceased 

at the plants which were operated by the armed services, or for them on a 

management-fee basis, during the war. 

PLANT CAPACITY AND CAPITAL EXPENDITURES 

The next question is what capital expenditures would be involved in 

providing the industrial capacity required for the anticipated level of 

activity in 1948. This question maybe divided into three parts: (1) How 

much effective plant capacity was in existence at the end of the war? (2) 

What will be the effect of transition adjustments which involve retiring 

some parts of existing plants and reducing the effective capacity of other 

parts? (3) What expenditures will be necessary to bring the residual capacity up to the levels required for 1948 output and at the same time to 

cover normal retirements of equipment in the interval? 

All of these questions presume some standard for measuring the plant 

capacity in existence at various times, for adding together the capacity of 

various industries, and then for converting anticipated changes into dollar 

expenditures. Such a standard, of course, does not exist. About all that 

can be done is to use dollar values of plant and equipment, as shown on 

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MANUFACTURING AND MINING INDUSTRIES 9 

financial statements of corporations, coupled with dollar figures for retirements and additions. In gauging the effective capacity represented by 

dollar book values, some allowance must be made for accounting deficiencies, for differences between the prewar prices at which plants were built 

and the postwar prices at which replacements and additions will be 

made, and for changes in effective capacity owing to variations in intensity 

of utilization—that is, in the number of hours a week that plants are 

worked. 

A serious obstacle to such calculations is the incompleteness of data 

since 1942 on plant valuations and retirements. The chief aspect on which 

information is available for recent years is expenditures for new plant and 

equipment. For Government financed plants the data were developed 

at the War Production Board, and for privately financed plants at the 

Board of Governors of the Federal Reserve System.5 

Need for New Plant Facilities, 1941-47. In view of statistical limitations, some of the difficult aspects of the recent war period have been 

bridged by using the amount of available industrial facilities and the 

volume of industrial production in 1941 as bench marks in obtaining comparable estimates. As is shown in the table on page 10, the gross book 

value of corporate plant facilities at the beginning of 1941 was 51 billion 

dollars. Since very little Government owned plant was being privately 

operated at that time, this was substantially the aggregate available for 

industrial operations in that year. 

If it be assumed that by 1948 virtually all industrial production outside 

of Government arsenals and Navy yards will again come from privately 

owned plants, that these will be worked with substantially the same intensity as in 1941, and that facilities consumed during the period 1941-47 

will have been replaced, then it may be supposed that the required increase in plant facilities will be about proportional to the projected increase in output.6 

beginning with 1945 the Department of Commerce and the Securities and Exchange 

Commission have secured quarterly reports on capital expenditures of a sample of manufacturers which will form the basis for more current statistics in the future. 

6The assumption of a 1948 intensity of plant utilization equal to 1941 is not quite consistent 

with the assumption involved in the projection of gross national product that the labor force 

will work shifts of the same length as in 1940, since average hours worked per week were about 

5 per cent less in 1940 than in 1941 and the number of hours of plant operation a week presumably corresponded with this. This factor, however, is perhaps less important than the ratio of 

number of employees to value of plant facilities; in this respect 1948 seems likely to resemble 

1941 more than 1940. 

In addition to the question of cyclical variation in intensity of utilization, there is a question 

whether in the long run plant facilities increase in proportion to increases in output. On the one 

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The projected level of industrial production for 1948 is substantially 

above the 1941 level; for the three broad industry groups of manufacturing and mining shown in the table the increases in industrial production 

from 1941 to 1948 ranged from 18 to 52 per cent. These increases may be 

PROJECTED NEED FOR PLANT ADDITIONS, 1941-47 

Broad Industry Groups of Manufacturing and Mining Corporations 

(In billions of dollars) 

Item 

Gross value of plant facilities, beginning of 19411.. 

Projected percentage increase in index of production, 1941 to 1948* 

Additional facilities, 1941-478 

Replacement of facilities, 1941-474 

Total required plant additions, 1941-47 

1

 Gross value of plant from U. S. Treasury Department, Statistics of Income for 1940. Data are before deductions of depreciation and exclude intangibles; they are adjusted to include corporations not submitting balance 

sheets. 

* Percentage increases based on 1948 projections as shown in table on p. 7, except that activity at Government arsenals. Navy yards, and depots is excluded from metals and products in 1941. Indexes used were (1935-39 

= 100): metals and products—207 for 1941 and 286 for 1948; petroleum, chemicals, rubber—165 for 1941 and 250 

for 1948; all other—134 for 1941 and 158 for 1948. 

» Gross value of plant at beginning of 1941 times projected percentage increases in industrial production 1941-

48. 

* Figures represent seven times the sum of the following items, reported in Statistics of Income for 1942: depreciation plus two-thirds of depletion plus one-fourth of amortization. Two-thirds of reported depletion is included 

as a rough allowance for new oil-well drillings and other mining prospecting needed to sustain mineral output. 

Amortization for 1942 is reduced to an equivalent of depreciation by taking one-fourth the reported amount, on 

the assumption that ordinary depreciation rates are only one-fourth of the 20 per cent a year allowed for 

amortization. 

presumed to require additions to plant facilities in 1941-47 totaling over 

17 billion dollars. 

Plant and equipment to be retired and replaced over the period 1941-47 

may be expected to total more than 16 billion dollars, on the basis of 

hand, there is certainly a possibility in many lines that increased scales of output result in 

certain plant economies, both for line production and for equipment and repair. On the other 

hand, a static cross-section of the manufacturing industry in any one year such as 1941 suggests 

that large companies use relatively more plant facilities in relation to sales than do smaller 

companies. Over a considerable period of time, there is also a distinct trend toward increasing 

the amount of capital equipment used per employee and this trend is likely to be accelerated in 

the early postwar years by pressure to keep labor costs at a minimum. On the whole it is probably not overstating the requirements for industrial facilities to assume an increase from 1941 

to 1948 in proportion to ti e projected increase in production. 

All manufacturing 

and mining 

51.1 

17.4 

16.4 

33.8 

Metals and 

products 

16.8 

38 

6.4 

6.0 

12.4 

Petroleum, 

chemicals, 

rubber 

14.5 

52 

1A 

5.2 

12.6 

All other 

19.8 

18 

3.6 

5.2 

8.8 

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allowances for depreciation, depletion, and amortization reported for 

1942 when the level of industrial production was approximately (slightly 

below) the prospective average for the years 1941-47. Additions to and 

replacement of plant facilities in 1941-47 will thus total 34 billion dollars. 

As an estimate of the capital expenditures required before the beginning 

of 1948, the figures in the table are subject to several distorting influences, 

some suggesting understatement and some overstatement. To begin with, 

the gross value of plant facilities at the beginning of 1941 is probably 20 

per cent or more understated owing to various writedowns which, in accordance with conservative accounting practice, have doubtless exceeded 

the amount of facilities actually retired from service. To this extent application of the required percentage increased from 1941 to 1948 results 

in understating the required additions to plant facilities. The replacement 

allowance for seven years' depreciation tends also to be understated since 

not all depreciation charges are identified as such in the statistical source 

from which the data were taken. It is also to be noted that the depreciation 

figure includes no allowance for accelerated amortization and replacement 

of privately owned war facilities. Finally, the indicated 34 billion dollar 

cost of net additions and replacements may be understated owing to increases in construction costs and equipment prices; the gross value of 

plant existing at the beginning of 1941 was largely in terms of prewar 

prices whereas wartime and postwar additions may reflect price increases 

of 20 per cent or more. 

More or less offsetting the price consideration is the possibility that 

the increased technological effectiveness of new materials and types of 

equipment in many lines may have compensated for changes in the dollar 

cost of like amounts of physical capacity. Similarly offsetting the understatement of depreciation allowances are two factors tending to keep 

"normal" replacements below the level of depreciation allowances. One 

is the fact that, during and for some time after a period of accelerated 

expansion of plant facilities, depreciation charges tend to rise much more 

quickly than normal retirements. The second factor is that, for the seven 

years 1941-47 as a whole, retirements will tend to be below normal owing 

to the wartime utilization of considerable amounts of over-age equipment, 

particularly in those categories which are normally replaced after three 

to five years. As a re'sult some of the retirements which would normally 

have occurred in the seven-year period will be deferred until after 1947. 

Possibly outweighing these two factors is the matter of accelerated 

obsolescence in the years immediately following the war, when many 

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innovations in materials, equipment, and production techniques will be 

introduced. To be sure, some of these changes will be introduced while 

deferred replacements are being made and thus will not involve the premature scrapping of existing equipment. But it seems altogether likely 

that, as new and improved equipment becomes more available, manufacturers will tend to replace some existing equipment before its normal 

retirement date. How much this factor may add to the capital expenditures of manufacturers is difficult to gauge. In the early postwar years 

1946 and 1947 the availability of equipment may be a practical limiting 

factor. Conceivably manufacturers may be able to increase expenditures 

on this account by as much as 2 or 3 billion dollars in these early postwar years. 

On balance it seems likely that the suggested figure of 34 billion dollars 

of additions to and replacements of plant facilities required in the sevenyear period is somewhat low. Consideration will next be given to the 

extent to which this expansion has been made during the war, and to the 

size of the indicated residual expansion to be made in 1945-47. 

Actual Plant Expansion, 1941-44. Under the exigencies of war production and of the preceding defense program, the principal expansions in 

new industrial facilities during 1941-44 occurred in the so-called war 

industries—metals and their products, and the petroleum, chemicals, 

and rubber group. It became Government policy to provide incentives to 

manufacturers for expanding war production facilities by granting priorities for materials and equipment and by legislative provision for charging 

off the cost of such facilities at an accelerated rate in computing taxable 

income. At the same time restrictions were increasingly applied against 

the use of critical materials for construction and equipment in civilian 

industries. 

These Government policies are reflected in the table on page 13, which 

presents the value of plant facilities installed during 1941-44. In the 

so-calledwar industries new privately financed facilities over the four-year 

period amounted to more than 9 billion dollars and equaled nearly 30 per 

cent of the gross value of previously existing plants; in non-war industries 

the amount was 3 billion, only 15 per cent of plant values in 1941. That 

capital expenditures in non-war industries were as high as they were 

reflects partly the fact that some of them, such as food and apparel, received substantial war contracts, and all of them obtained substantial 

materials and equipment for maintenance, repair, and operation under 

the provision exempting small purchases from priority requirements. 

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MANUFACTURING AND MINING INDUSTRIES 13 

The materials could be used by regular plant labor to construct new facilities, and there was probably a very great increase in the extent to which 

this was done. 

Notwithstanding the arrangements for encouraging private construction of war plants, private concerns were in general willing to construct 

only such facilities as would be usable in postwar civilian production. 

Most of the more specialized facilities, including some equipment installed 

PROJECTED NEED TOR PLANT ADDITIONS, 1945-47 

Broad Industry Groups of Manufacturing and Mining Corporations 

(In billions of dollars) 

Item 

Total required plant additions, 1941-471. . 

New plant facilities installed, 1941-44, total2. . 

Privately owned 

Government owned: 

Privately operated 

Government operated 

Government owned facilities usable after war3. . 

Total new plant facilities, 1941-44, usable 

after war 

New facilities needed, 1945-47 

All manufacturing 

and mining 

33.8 

26.2 

12.2 

10.7 

3.3 

5.2 

17.4 

16.4 

Metals and 

products 

12.4 

16.7 

4.4 

9.0 

3.3 

3.$ 

8.2 

4.2 

Petroleum, 

chemicals, 

rubber 

12.6 

6.3 

4.8 

1.5 

1.2 

6.0 

6.6 

All other 

8.8 

3.2 

3.0 

0.2 

0.2 

3.2 

5.6 

1

 Figures are from table on p. 10. 

* Privately owned facilities are estimates of Board of Governors of the Federal Reserve System. Estimates of 

Government owned facilities are from the following publications: Civilian Production Administration, WarCreated Manufacturing Plant Federally Financed, 1940-1944, Nov. 15, 1945, and Facilities Expansion, July 1940-

June 1945, Jan. 16,1946. Figures exclude 0.7 billion dollars under private ownership and 1.7 billion operated within 

arsenals and Navy yards. (It is assumed the latter will be retained by the Government indefinitely.) Figures for 

Government operated and owned plants represent plants operated on a fee basis by private concerns but with 

sales, costs, inventories, and plants excluded from corporate financial statements. 

* Estimates of usable Government owned installations are described on p. 14. 

within private plants, was provided under Government ownership. Thus 

the risk that an early end to the war might leave business saddled with 

unusable facilities was obviated. As is shown in the accompanying table, 

about 11 billion dollars of Government owned facilities were leased for 

private operation, many with a postwar option to purchase. Facilities 

costing about 3 billion dollars were merely managed by private companies 

on a fee basis, but sales and expenses from these plants were handled 

through Government accounts and were not reflected in private financial 

statements except as regards the management fee, 

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Plant Expansion in 1941-44 Usable after War. Industrial facilities 

provided during the period 1941-44 totaled 26 billion dollars. The 

privately financed total of 12 billion will be shifted easily to postwar 

civilian production. However, only a part of the 14 billion of Government 

owned facilities will have a peacetime use, and the usable facilities will 

gradually be acquired by manufacturers through lease from the Government or through purchase as surplus war property. Both the plant 

expansion and the capital expenditures of business in the early postwar 

years will be correspondingly affected. The extent to which industrial 

plants constructed under Government ownership during the war will be 

taken over by private business is a major element in the postwar need 

for new plant construction, and the terms on which Government plants 

are taken over will affect the need of business for funds. 

Prevailing opinion seems to be that about two-thirds of the Government 

owned war plants will not be adaptable to postwar production. In reporting on these plants the Civilian Production Administration stated that 

"not more than 4 billion dollars of the new [Government] plant is readily 

usable in peacetime. The remainder must be (1) kept in standby condition 

for use in future military contingencies; (2) scrapped as part of the 

"expendables'' of warfare; or (3) adapted (often at considerable cost) 

to some peacetime production for which a market exists or can be 

created."7 

If it is assumed that plant facilities classified in the Civilian Production 

Administration report as having "definite peacetime value" are only 80 

per cent equivalent to those under private ownership owing to the reduced 

emphasis on construction cost, and if a limited adaptability for peacetime 

use—say 10 per cent—is allowed for facilities classified by the report as 

"largely irreclaimable," a rough estimate of 5.2 billion dollars is obtained 

for Government owned plant facilities that may be operated after the 

war.8 

The significance of these assumptions in estimating private plant 

expansion needed during the years 1945-47 in order to meet production 

7Civilian Production Administration, War-created Manufacturing Plant Federally Financed, 1940-1944, Nov. 15,1945, p. 3. 

8More specifically, it is assumed here that Government owned plants will be operated after 

the war only to the extent of (1) 10 per cent of the Government owned and operated plants 

in all industries; (2) 10 per cent of other privately operated Government facilities for producing 

ships, guns, explosives, and ammunition; (3) 25 per cent of the privately operated Government 

owned aircraft facilities; (4) 80 per cent of privately operated Government facilities in other 

industries. 

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MANUFACTURING AND MINING INDUSTRIES 15 

needs in 1948 is brought out in the table on page 13. The value of Government owned facilities assumed to be usable after the war is added to the 

privately owned facilities constructed during the period 1941-44 in order 

to arrive at the amount available from the period for meeting 1948 

production needs. The difference between this amount and the projected 

total requirements for the seven-year period 1941-47 is the residual 

amount of new facility construction needed during the years 1945-47. 

The analysis suggests that this residual of 16 billion dollars will be distributed by broad industry groups quite differently from the wartime 

additions, in that relatively more of the postwar expansion will be needed 

in non-war industries. 

Whether this amount of new facilities can become available to industrial 

concerns during this period will depend partly on how fast the output of 

equipment and construction materials can proceed. It will depend also on 

the volume of demand for equipment for transportation, public utilities, 

trade, service, and agriculture, and also for foreign reconstruction. In 

comparison with the private facility expansions of previous years (made 

at lower prices), and the increased capacity presently available in machinery and equipment industries, the projected 16 billion dollars appears a 

feasible figure. 

Prospective Capital Expenditures, 1945 to Mid-1948. Capital expenditures of manufacturing and mining companies needed in 1945-47 to 

provide plant capacity for the projected level of industrial production in 

1948 will include expenditures for new facilities constructed during the 

period and some purchases of existing Government owned plants. 

There is little basis for guessing what proportion of the 5.2 billion 

dollars of usable Government facilities shown on page 13 will be leased 

to private business and what proportion sold, or how much of the latter 

may be financed by Government instalment sale credit rather than by 

bank or security financing. For illustration it may be assumed that onethird will be sold outright, one-third leased, and one-third financed by 

Government instalment credit. In this event about 3.5 billion dollars 

worth of usable war facilities would be purchased, although, as will be 

brought out, it would not necessarily involve this amount of expenditures. 

The cost to business of acquiring these facilities would be somewhat 

less than their original cost. During the past two years a number of large 

Government plants have been transferred to private ownership at 35 

to 40 per cent below their original cost. This is a greater markdown than 

the 20 per cent discount assumed on page 14 in adjusting the value of 

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16 PRIVATE CAPITAL REQUIREMENTS 

Government construction to comparable private construction. The 

importance of this development to the present analysis is that the larger 

discounts probably reflect a reduced life expectancy of the plants more 

than a reduced current physical capacity. In terms of current capacity, 

the purchase of Government plants thus means smaller capital outlays 

than would be involved in construction of corresponding new facilities. 

Should Government plants be purchased at close to 20 per cent below the 

"private ownership equivalent" used in the table on page 13, the capacity 

described as "3.5 billion dollars worth" might cost corporations about 

2.7 billion, of which half would be Government sale credit and half would 

be private funds. About three-fourths of these purchases will be facilities 

in the metals and products industries. 

In order to bring the over-all financing requirements of manufacturing 

and mining corporations up to the date covered by the analysis in this 

paper—to mid-1948 (three years after the end of the war)—it is necessary 

to include capital expenditures for the first half of 1948. These figures, 

given below, represent an extension of the end-of-1947 rate that is consistent with estimates of total capital expenditures for 1945-47. 

COMPONENTS OF CAPITAL EXPENDITURES, 1945-MID-1948 

Broad Industry Groups of Manufacturing and Mining Corporations 

(In billions of dollars) 

Component 

Purchase of usable Government owned 

facilities 

Expenditures, first half of 1948 

Total, 1945 to mid-1948 

All manufacturing 

and mining 

16.4 

2.7 

4.0 

23.1 

Metals 

and 

products 

4.2 

2.0 

1.3 

7.5 

Petroleum, 

chemicals, 

rubber 

6.6 

0.6 

1.5 

8.7 

All 

other 

5.6 

0.1 

1.2 

6.9 

1

 From table on p. 13. 

Capital expenditures of 16.4 billion dollars for new facilities and of 2.7 

billion for purchase of existing Government owned facilities in the 1945-47 

period, together with 4.0 billion for the first half of 1948, brings the 

total for the three and one-half years to 23 billion. As discussed earlier, 

on page 12, an additional 2 or 3 billion dollars might be spent if supply 

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conditions permit introduction of more extensive technological improvements. 

INVENTORIES AND OTHER WORKING CAPITAL NEEDS 

Outlays for larger inventories and extension of customer credit will 

accompany business expenditures for maintaining and enlarging plant 

capacity after the war. Liquid asset requirements for current operating 

purposes will also be larger than they were before the war, but in most 

lines they will probably be smaller than the amounts of cash and Government securities on hand at the close of the war. 

As in the case of plant capacity, prewar relationships are probably a 

better guide to postwar tendencies than is the wartime experience. The 

latter is strongly affected by such transitory factors as special inventory 

and credit arrangements under Government war contracts, restrictions 

on the purchase of raw materials and the inability to use funds for expanding plant and equipment, high excess profits taxes, and the like. 

Since 1941 is the latest year free from most of these factors, the relationship existing then between the various items of working capital, such as 

liquid assets, and dollar sales has been applied to the sales volume that 

might obtain in 1948 under earlier postulates in order to obtain an 

approximate estimate of requirements. The two years 1941 and 1948, 

however, are so far separated both in time and in level of industrial 

activity that subjective judgment must influence the result to a very great 

extent. In addition, the projections are subject to considerable variability 

depending on other developments in the national economy. These will be 

mentioned but quantitative account of their effect is hardly possible at 

this time. 

Projected Dollar Sales in 1948. The pattern of industrial output projected on page 7 for 1948 is stated in terms of the Federal Reserve index 

of physical production. In converting these data into dollar sales consistent with the assumption of a general price level 12 per cent above 1945, 

some assumptions based on the past trend of prices were made regarding 

the distribution of the price rise by broad industrial groups. 

For the years 1939, 1941, and 1945, the table on page 18 presents a 

comparison of the indexes of physical production, dollar sales, and the 

price trend that is implied in the relation of these data. Among the three 

broad industrial groups, the past output and sales data suggest considerable differences in 1945 price levels as compared to 1939. Only a 7 per cent 

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18 PRIVATE CAPITAL REQUIREMENTS 

rise is indicated for the petroleum, chemicals, and rubber group in contrast 

to 21 per cent for metals and products, and 58 per cent for the "all 

other" group.9 It has been assumed for the petroleum, chemicals, and 

rubber group that whatever factors—either in technology or in the production index itself—have been responsible for the indicated smaller 

price increases in the past will continue in the future. Accordingly a 

further increase of only 2 per cent by 1948 is assumed in the implicit 

PROJECTED INDUSTRIAL PRODUCTION AND SALES FOR 1948 

COMPARED WITH 1939, 1941, AND 1945 

Broad Industry Groups of Manufacturing and Mining Corporations 

Industry group 

Metals and products: 

1939 

1941 

1945 

1948 

Petroleum, chemicals, rubber: 

1939 

1941 

1945 

1948 

All other: 

1939 

1941 

1945 

1948 

NOTE.—Indexes of production are based on Federal Reserve index of industrial production; the metals 

component of minerals is included with metals and products and the crude petroleum component with petroleum, 

chemicals, and rubber since they are thus included in the figures on sales. Sales for 1939 arid 1941 are based on 

data in U. S. Treasury Department, Statistics of Income; those for 1945 are estimated on the basis of past relationship between shipments (U. S. Department of Commerce data) and sales (Statistics of Income). Estimates 

for 1948 are described in the accompanying text. 

price index for this group. By combining this price index with the posited 

index of physical production in 1948, dollar sales amounting to 22 billion 

dollars were derived. This level is slightly lower than in 1945 but about 

44 per cent higher than in 1941. 

9

 These figures differ from the increases shown by the wholesale price indexes of the Bureau 

of Labor Statistics for comparable groups. For example, the BLS index Qf chemicals and allied 

products shows an increase of over 25 per cent while the index of metals and products shows 

an increase of 9 per cent. 

Index of production 

(1935-39 - 100) 

108 

206 

288 

275 

110 

144 

208 

201 

108 

136 

138 

162 

Dollar sales 

(billions) 

18.0 

36.9 

58.0 

63.3 

11.2 

15.5 

22.6 

22.3 

30.8 

43.4 

62.3 

83.2 

Implied price index 

(1939 - 100) 

100 

107 

121 

138 

100 

106 

107 

109 

100 

112 

158 

180 

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For other industrial groups it seems likely that larger price increases 

may be expected. Some of these increases (as in metal products) may be 

coupled with technical improvements in product, while others (including 

those related to residential construction) will reflect impatient consumer 

buying in the face of limited supplies. For simplicity in working out the 

projections, implicit price increases in the metal products and "all other" 

groups were assumed to be about 14 per cent from 1945 to 1948; with 

this increase the weighted average price increase for all industrial groups 

equals the 12 per cent previously posited in estimating gross national 

product. Combining the implied price index for metals and products with 

the production index results in a projection of sales amounting to 63 

billion dollars. This is an increase of about 70 per cent over 1941 and 10 

per cent over 1945. The same procedure for the "all other" group indicates sales amounting to 83 billion dollars in 1948, an increase of over 

90 per cent over 1941 and about 35 per cent over 1945. For convenience, 

it will be assumed that these sales levels represent both the annual totals 

for 1948 and the annual rates which will obtain at the middle of the year. 

Outlook for Inventory Expansion. In general it is probably safe to 

assume that the inventories which manufacturing and mining concerns 

will tend to hold in 1948 will not be proportionately as much above 1941 

as the level of sales. Statistical analysis of the inventory-sales relation 

back to 1929 indicates that changes in inventories tend to lag behind 

changes in sales and, even after allowance for time lag, they tend to be 

proportionately smaller. So far as raw materials and their components 

are concerned, this tendency arises from the fact that inventories serve 

partly as a reservoir to safeguard against irregularity in receipt of new 

materials. Consequently the size of the inventory would not ordinarily 

be expected to vary in proportion to the level of sales. 

In gauging 1948 prospects, however, the application of previous relationships of inventory to sales leaves considerable latitude for qualitative 

judgment. Not only is it likely that the 1948 sales volume will exceed the 

range of previous experience, but factors of a qualitative nature may well 

be important. Among these may be a tendency of manufacturers toward 

abnormally large inventories if prices should be rising sharply or if supply 

or labor conditions should make the receipt of additional materials 

uncertain. On the other hand, it is possible that under wartime pressures 

business concerns may have learned how to program their inventory 

requirements more closely with current operations and may thus be able 

to get along with relatively smaller inventories than before the war. 

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The data for mid-1948 presented below reflect these considerations as 

well as the relationship of inventories to sales in former years. 

PROJECTED INVENTORIES AND LIQUID ASSETS FOR 1948 

COMPARED WITH 1941 AND 1944 

Broad Industry Groups of Manufacturing and Mining Corporations 

(In billions of dollars) 

Industry group 

All manufacturing and mining: 

Sales 

Inventories 

Liquid assets, total 

Cash 

Government securities... . 

Metals and products: 

Sales 

Inventories 

Liquid assets, total 

Cash 

Government securities 

Petroleum, chemicals, rubber: 

Inventories 

Liquid assets, total 

Cash 

Government securities 

All other: 

Sales 

Inventories 

Liquid assets, total 

Cash 

Government securities 

End of year 

1941 

103.1 

16.8 

9.6 

6.8 

2.8 

40.6 

7.1 

4.8 

3.2 

1.6 

17.0 

2.7 

1.9 

1.4 

0.5 

45.5 

7.0 

2.9 

2.2 

0.7 

1944 

161.9 

19.2 

25.0 

12.3 

42. 7 

73.0 

9.4 

12.6 

5.9 

'6.7 

22.7 

2.7 

3.7 

2.1 

n.6 

66.2 

7.1 

8.7 

4.3 

J

4.4 

Mid-1948 

168.8 

24.1 

16.4 

10.8 

5.6 

63.3 

10.2 

7.5 

5.0 

2.5 

22.3 

3.3 

2.5 

1.8 

0 7 

83.2 

10.6 

6.4 

4.0 

2.4 

1

 Includes estimated postwar credits on excess profits taxes, as follows: metals and products, 0.9; petroleum, 

chemicals, and rubber, 0.1; and all other, 0.4 billion dollars. 

NOTE.—Inventories, liquid assets, and other balance sheet data for 1941 shown in subsequent tables are corporate balance sheet data from U. S. Treasury Department, Statistics of Income for 1941, adjusted to include corporations not submitting balance sheets; those for 1944 are Statistics of Income data for 1940, projected to 1944 on 

the basis of 1940-44 changes for a sample of manufacturing and mining companies. Estimates of inventories and 

liquid assets for 1948 are described on pp. 19 and 22, respectively. 

Sales are based on data in table on p. 18; for 1941 and 1944 sales are annual rates for last quarter of year, and 

for 1948 for the second quarter, which is assumed to be the same as the year. 

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MANUFACTURING AND MINING INDUSTRIES 21 

The projected inventory holdings for mid-1948 suggest that the bulk 

of the postwar expansion in inventories may be in the "all other" group 

of industries. These are predominantly "non-war" industries, including 

food and clothing production where sharply rising prices during recent 

years have tended to conceal the fact that physical inventories have been 

drawn down substantially below prewar levels. The replenishing of inventories in these lines to normal levels, coupled with expansion to keep pace 

with rising sales of civilian goods, may raise inventories by 3.5 billion 

dollars between 1944 and 1948. 

In the metal products group and also the petroleum, chemicals, and 

rubber industries, the renewal of inventories was also restricted in wartime. Here, however, the rate of sales may be lower in 1948 than in the 

war year 1944 so that the need for inventory expansion will be considerably less than in the "all other" lines where sales will be expanding. 

An aggregate increase of 1.4 billion dollars has been projected for these 

industries. 

The volume of production needed to expand inventories over the 1944 

to mid-1948 period will be somewhat greater than is indicated by the inventory estimate, especially in the metal products industries, where 

scrapping of some war inventories has been extensive. According to 

Department of Commerce estimates, "war inventories" in the durable 

goods industries amounted to about 6.5 billion dollars in June 1945. By 

June 1946 about half of that amount may have been retained at the site 

or, if taken over by the Government, may have been resold to other 

manufacturers. The special purpose items remaining might be scrapped 

and then resold for a fraction of their former book value. Completion of 

this process might eliminate 2 to 3 billion dollars worth of inventories 

from the economy. From the standpoint of the drain on private funds, 

however, the loss incurred as a result of the shift of inventories from war to 

civilian use was probably not important since such losses were presumably 

covered by payments received in settling Government contracts. 

Need for Liquid Assets. If business conditions should be as favorable 

as projected here, manufacturers in general may have easier access than 

ever before to new funds, both for long-term investment purposes and for 

increasing working capital items. In that event they may well prefer to 

retain the very liquid position that developed during the war and to 

secure funds for expanding other assets by increasing bank loans and 

outstanding securities. If, on the other hand, manufacturers should prefer 

to keep debt at a minimum and to draw down their liquid balances with 

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22 PRIVATE CAPITAL REQUIREMENTS 

the expectation of replenishing them out of subsequent earnings, their 

cash and Government security holdings might decline to the minimum 

amount required for current operating purposes. 

It is difficult to gauge how far industrial concerns will go in drawing 

down liquid assets or what their operating requirements for liquid assets 

will be. Theoretically liquid asset requirements may be classified in three 

parts: (1) an amount needed to make frequent cash disbursements for 

pay rolls and other costs, in cases where receipts from sales come in only 

periodically; (2) amounts accumulated for infrequent or special payments 

such as capital expenditures, income taxes, and debt retirement; (3) 

an extra margin to cover contingencies such as unforeseen delays in 

receipts. It seems likely that these elements vary less than proportionately 

with sales, although certain conditions (such as short supplies or rising 

prices) may tend to increase the desire for liquid assets in order to take 

advantage of market opportunities.10 

For the purpose of this article it is assumed that requirements for cash 

in manufacturing and mining industries may be gauged by applying to the 

projected level of sales for 1948 the ratio of cash to sales which obtained 

at the end of 1941. The cash-sales ratio was on the whole as low in 1941 

as at any time in the past 10 years. As regards Government security 

holdings, it will be assumed that "operating requirements'' will call for 

holding securities in an amount equal to outstanding income tax liabilities. 

Before the war, when Federal income taxes were not a large factor in outstanding liabilities, they were not generally matched by holdings of 

Government securities. During the war, however, many medium and 

larger size companies appear to have followed a policy of "funding" 

their accrued tax liabilities by purchasing an equal amount of tax notes 

and other Government securities. It seems likely that this practice will 

continue. 

On the basis of these assumptions the projected operating requirements 

for liquid assets in 1948 have been estimated as shown in the table on page 

20. The estimates indicate that operating requirements for liquid assets 

for all manufacturing and mining concerns in mid-1948 may amount to 

16 billion dollars, compared with total holdings at the end of 1944 of 

25 billion. Possibly about 9 billion dollars, or more than one-third of the 

10For a statistical inquiry into the factors affecting cash holdings of large manufacturers, see 

Avram Kisselgoff, "Liquidity Preference of Large Manufacturing Corporations (1921-1939)," 

Econometrica, October 1945. This article is an elaboration of a discussion that appeared earlier 

in Freidrich Lutz, Corporate Cash Balances, 1914-43. 

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MANUFACTURING AND MINING INDUSTRIES 23 

liquid assets held at the end of 1944, may thus be in excess of 1948 operating requirements, and these funds may be used for other purposes. The 

proportion of liquid asset holdings at the end of 1944 which may be 

available for purposes other than operating requirements appears to be 

largest in the metal products industries and smallest in the "all other" 

group. 

Net Extension of Trade Credit and Other Working Capital Items. 

In general, credit extended by manufacturing and mining companies 

exceeds on balance the credit received by these companies from other 

businesses, and the excess tends to vary with the level of operations. 

During the war the relationship of net trade credit to sales varied somewhat erratically, owing partly to special practices in connection with 

Government contracts that were designed to reduce the amount of outside 

financing required by business concerns. Data for the war period thus 

provide an uncertain base for projecting the amount of credit likely to be 

extended in 1948. This limitation applies to the projections given in the 

table on page 24, which indicate the possible amounts of credit to be 

extended and received by manufacturing and mining companies in the 

three broad industrial groups. 

In 1948 as compared with 1941 and 1944, the projections suggest 

little or no expansion in net customer credit extended by the metal 

products group, but a possible expansion of nearly 2 billion dollars by the 

other groups. 

Ordinarily in peacetime the accrual of short-term liabilities other than 

bank loans has been a minor but steady source of funds in times of business 

expansion. Disbursements for wages, interest, rent, taxes, and the like 

are made more or less periodically, but they are provided for in advance 

as they accrue. This source of funds is quasi-internal in character in that 

accrual accounts increase more or less automatically with increases in 

dollar sales and are continuously replenished to meet future liabilities 

as old liabilities are paid off. Any increase in total accrued liabilities 

provides funds that can be used to increase assets until such time as the 

volume of sales declines and the outstanding amount of such liabilities 

has to be reduced. This form of financing resembles external financing 

in that the business becomes subject to the contingency of paying funds 

to outsiders at a time when the level of operations and cost accruals are 

declining. 

In view of the comparatively high level of operations in the war industries at the end of 1944 and the high wartime tax rates then prevailing, 

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24 PRIVATE CAPITAL REQUIREMENTS 

PROJECTED EXTENSION OF TRADE CREDIT FOR 1948 

COMPARED WITH 1941 AND 1944 

Broad Industry Groups of Manufacturing and Mining Corporations 

(In billions of dollars) 

Industry group 

All manufacturing and mining: 

Receivables 

Less: 

Accounts payable 

Government advances 

Excess of receivables 

Metals and products: 

Receivables 

Le s: 

Accounts payable 

Government advances 

Excess of receivables 

Petroleum, chemicals, rubber: 

Receivables 

Less: 

Accounts payable 

Government advances 

Excess of receivables 

All other: 

Receivables 

Less: 

Accounts payable 

Government advances 

Excess of receivables 

End of year 

1941 

11.7 

6.2 

0.8 

4.6 

4.7 

2.2 

0.8 

1.7 

2.4 

1.5 

0.0 

0.8 

4.6 

2.5 

0.0 

2.1 

1944 

16.2 

8.2 

1.8 

6.2 

8.4 

3.6 

1.5 

3.2 

3.2 

2.4 

0.2 

0.6 

4.6 

2.2 

0.1 

2.3 

Mid-1948 

17.9 

10.0 

7.9 

7.3 

4.0 

3.3 

3.1 

2.0 

1.2 

7.5 

4.0 

3.5 

NOTE.—Figures for 1941 and 1944 are derived as described in note to table on p. 20. Estimates for 1948 are 

described on p. 23. Receivables include amounts due from Government. Because of rounding, figures do not 

always balance to "excess" shown. 

the projected level of accrued liabilities for 1948 seems likely to involve 

a drain rather than a source of funds. The table on page 33 indicates the 

general magnitude in the shift in accrued liabilities that may be realized 

by mid-1948. For all manufacturing and mining companies the drain of 

funds between 1944 and 1948 as accrued liabilities decline may total nearly 

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6 billion dollars (excluding Government advances). The greater part of 

this drain will be concentrated in the metal products group. 

FINANCING POSTWAR NEEDS 

In general the expansion in business assets during periods of rising 

business activity is firtanced from three broad sources—depreciation 

allowances for replacing plant and equipment, retained profits after 

dividend payments, and external financing. External financing has been 

a more important source of funds in public utilities and railroad industries 

than in manufacturing and mining industries. More important to manufacturers have been the funds derived from internal sources—retained 

profits and depreciation allowances. 

The magnitude of various sources of funds for the three broad industrial 

groups will be considered next. The general proportions of these sources 

of financing do not differ greatly among the three groups. The much 

greater capital expenditures projected for the petroleum, chemicals, and 

rubber group indicate that it may have the greatest need for outside 

financing. Substantial outside financing is indicated also for the "all other" 

or "non-war" group, where both output and prices are likely to rise sharply. In contrast the indicated projections for metal products industries 

suggest a plethora of internal funds. 

The aggregate of the needs of individual companies for external financing will necessarily exceed the net need indicated for the group. Some 

companies will have excess funds while others will have shortages and the 

practical need for financing will depend on the sum of the shortages without regard for the excesses. Beyond this consideration it should be borne 

in mind that the estimates and conclusions in this paper rest largely 

on assumptions, the validity of which will depend on many developments 

that are not at all clearly foreseeable. 

For the period following the end of the war, especially in the case of 

the metal products industries, funds from internal sources will be augmented by certain transitional adjustments. These adjustments occurred 

for the most part in 1945 and tended mostly to reduce taxable income of 

the war years and thus to result in tax credits. The application of these 

tax credits to 1945 tax liabilities reduced tax payments, especially in 1946, 

and internal funds were correspondingly larger. These adjustments have 

aided in financing postwar expansion. 

Financial Adjustments of the Transition. From the standpoint of 

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26 PRIVATE CAPITAL REQUIREMENTS 

time to peacetime business has consisted of liquidating certain assets 

and liabilities that had been built up during the war and (so far as permitted by available equipment and supplies) of adding other assets 

and other liabilities. 

During the transition period the liquidation of assets, including 

Government securities, will provide some funds for the reduction of 

wartime liabilities, but differences in timing of receipts and disbursements will probably result in temporary drains of funds for some companies. These drains will be augmented by current outlays for rebuilding 

inventories, renovating and replacing plant and equipment, reestablishing market outlets, and extending customer credit. In many cases these 

adjustments, peculiar to the transition period, will be accompanied by 

expenditures to initiate postwar expansion programs. 

As a consequence, the transition period will probably involve a considerable need for external financing by business. Some funds will be used 

merely for interim purposes, while other funds will be used for more or 

less permanent additions to working capital and long-term assets. In 

the process it is to be expected that both banks and security markets 

will share in providing the funds, with the proportions coming from each 

depending partly on the terms and conditions granted. 

In the first six months of the transition period, from June to December 

1945, the external financing of manufacturing and mining concerns has 

been substantial. Bank loans and security issues to raise new capital 

appear to have totaled over half a billion dollars. Supplementing these 

private sources of funds were the partial payments made by Government 

procurement agencies to war contractors before final settlement of contract claims. By the end of December 1945 applications for such payments 

had been approved totaling 1.8 billion dollars. That the demand for new 

financing was not greater during the early transition period reflected the 

large liquid balances with which most business concerns ended the war 

and the time required for new industrial equipment and supplies to become freely available in the market. In the first few months after the 

close of the war (to early 1946), reconversion appeared to be progressing 

more rapidly than had been anticipated as inventory controls were lifted 

and both materials and labor became available for immediate resumption 

of war-scarce products. Subsequently, however, limitations on the flow 

of materials and components, coupled with some interruptions from labor 

disputes, retarded the growth in output of industrial equipment and 

limited inventory expansion in all lines. 

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For the purpose of gauging the prospective need for financing to mid1948, however, some of the interim financing may be ignored. Some 

borrowing will be retired from the proceeds of Government contracts, 

while other borrowing may be retired from retained profits in 1946 and 

1947. From the standpoint of the postwar period as a whole, the principal 

transition adjustments that need to be taken into account are those relating to tax credits and reconversion costs. 

Among the most important of these was the accelerated amortization 

of plant facilities erected for war production. In order to promote the 

construction of facilities for war needs the Second Revenue Act of 1940 

provided that new plants which were certified as necessary by the war 

procurement services could be amortized for tax purposes over a 60-month 

period. Should the facilities become nonessential before the end of 60 

months, producers might secure a certificate of non-necessity and 

reallocate the unamortized portion over the previous life of the property. 

This reallocation would result in tax credits for previous years amounting 

to perhaps 75 per cent of the reallocated value. 

For the purpose of these tax provisions, the President terminated the 

emergency on September 29, 1945, thus permitting owners to complete 

the amortization of war plants. Some corporations (in reporting to stockholders) indicated that they would not exercise this option because of the 

distorting effect it would have on cost relationships in the early postwar 

years. Most corporations, however, appear to have completed amortization of their facilities for tax purposes but to have arranged by a variety 

of accounting adjustments to avoid having their net profit affected by 

this procedure. For the purpose of the present analysis it will be assumed 

that substantially all the unamortized war facilities will be written off 

before 1948 with resulting tax credits at approximately 75 per cent of the 

amortization. From September 1940 through August 1945 certificates of 

necessity amounting to 4 billion dollars had been issued to manufacturing 

and mining concerns, and it appears that about 45 per cent of the facilities 

represented had not been amortized by the end of September 1945. The 

amount of unamortized manufacturing and mining facilities amounted to 

about 1.9 billion dollars, with an indicated tax credit of 75 per cent or 1.4 

billion. As is shown in the table on page 31, about two-thirds of this 

accelerated amortization was in the metals products industry. 

Viewed in terms of the use of funds, these credits entailed a reduction 

in outstanding tax liabilities at the end of 1945 without a corresponding 

reduction in liquid assets. Instead, the offsetting balance sheet changes 

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28 PRIVATE CAPITAL REQUIREMENTS 

consisted mainly of a writedown of the property account with only a 

small reduction in net profit. The net effect was an increase of some 1.4 

billion dollars in available internal funds. 

A second transition adjustment affecting business funds was the financing of plant reconversion to peacetime production. Outlays for this 

purpose may have totaled 0.5 billion dollars in 1945 and were made largely 

in the metal products industries. However, tax credits resulting from the 

outlays represented a substantial proportion of the amounts involved. 

Another important balance sheet adjustment during the latter part 

of 1945 resulted from the availability of postwar credits accumulated by 

manufacturing and mining concerns on their excess profits taxes for the 

years 1942 through 1945. At the end of 1944 these credits, and the bonds 

evidencing them, amounted to about 0.92 billion dollars in the metal 

products industries, 0.13 billion in the petroleum, chemicals, and rubber 

group, and 0.38 billion in the "all other" group. In order to make the 

credits available at a time when they might aid the adjustment to peacetime production, the Tax Adjustment Act of 1945 provided that bonds 

which had been issued for the postwar credits on 1942 and 1943 taxes 

should be redeemable on or after January 1, 1946, and that the credits on 

1944 and 1945 taxes should be immediately applicable to tax liabilities of 

those years.11 

Other adjustments in financial statements following the war will involve recoveries on foreign subsidiaries that had been written off in 1941 

and 1942. These recoveries will presumably entail an increase in tax 

liabilities. Estimates are not yet available on the magnitude of this 

adjustment. 

Internal Sources of Funds. Probably the most important factor affecting the need for outside financing during the postwar expansion is the 

amount of earnings to be retained after deduction of costs and charges, 

taxes, and dividends. This, in turn, will depend on the volume of sales, 

business and Government policies with respect to prices, a variety of costs 

(with wage rates and technological productivity the main questions), 

possible legislative action in further reducing corporate income tax rates, 

and business policies with respect to dividend payments. 

uThese provisions accelerated the availability of credits provided under earlier revenue 

acts and led to reclassification of certain noncurrent assets into the short-term category, thus 

increasing the amounts classifiable as current working capital and liquid assets. In the classification of assets used in the present analysis, however, postwar credits through the end of 1944 

were included with Government security holdings and consequently their accelerated availability does not enter the picture as it has been presented here. 

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MANUFACTURING AND MINING INDUSTRIES 29 

In projecting to mid-1948 the possible earnings available after 

dividends, the volume of profits before taxes was first estimated by 

applying the relationship between sales and profits before taxes for the 

period 1939-43 to the sales projections for later years. In making this 

projection for the metal products group, some allowance was made for 

PROJECTED ELEMENTS IN RETAINED PROFITS, 1945-48 

Broad Industry Groups of Manufacturing and Mining Corporations 

(In billions of dollars) 

Industry group 

All manufacturing and mining: 

Sales , 

Profits before income taxes.. 

Net profits (after taxes) 

Dividends 

Retained profits 

Metals and products: 

Sales 

Profits before income taxes.. 

Net profits (after taxes) 

Dividends 

Retained profits 

Petroleum, chemicals, rubber: 

Sales 

Profits before income taxes.. 

Net profits (after taxes) 

Dividends 

Retained profits 

All other: 

Sales 

Profits before income taxes.. 

Net profits (after taxes) 

Dividends 

Retained profits 

1945 

142.9 

I 15.5 

5.5 

3.2 

2.3 

58.0 

7.7 

2.5 

1.2 

1.3 

22.6 

2.5 

1.1 

0.9 

0.2 

62.3 

5.3 

1.9 

1.1 

0.8 

1946 

145.0 

13.6 

8.7 

4.0 

4.7 

55.0 

5.5 

3.4 

1.5 

1.9 

20.0 

2.2 

1.6 

1.0 

0.6 

70.0 

5.9 

3.7 

1.5 

2.2 

1947 

160.2 

14.9 

9.4 

5.1 

4.3 

61.0 

6.3 

3.9 

2.0 

1.9 

21.2 

2.3 

1.6 

1.1 

0.5 

78.0 

6.3 

3.9 

2.0 

1.9 

1948 

(6 months) 

84.4 

7.7 

4.8 

3.1 

1.7 

31.6 

3.3 

2.0 

1.5 

0.5 

11.1 

1.2 

0.8 

0.6 

0.2 

41.6 

3.2 

2.0 

1.0 

1.0 

NOTE.—Estimates described on pp. 29-30. Figures for 1945 exclude special reconversion outlays and plant adjustments, since these are assumed to have been charged to reserves or surplus. 

higher costs by assuming that half the saving resulting from the elimination of the excess profits tax at the end of 1945 will be passed along to labor 

and other elements in the cost structure. It should be emphasized that this 

adjustment is merely a guess. Since both sales and pay rolls are typically 

several times as large as profits before taxes, relatively large fluctuations 

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30 PRIVATE CAPITAL REQUIREMENTS 

in the latter may follow relatively small changes in prices or wage rates. 

Actual profits before taxes might be 50 per cent larger or smaller than 

the projections shown in the table on page 29. A comparatively small 

allowance for such an increase in costs was included in the projection for 

the petroleum, chemicals, and rubber group, while figures for the "all 

other" group include virtually no adjustment for increased costs beyond 

extension of the trend of the 1939-43 relationship of profits to sales. 

In projecting taxes and dividends—the other elements affecting retained earnings—it has been assumed that in general effective income 

tax rates will average about 38 per cent, and that dividends will at first 

increase much less than net profit but will tend in 1947 and 1948 to increase more rapidly and to approach the prewar relation, when dividends 

were approximately two-thirds of net profit. 

The estimates of net profit (after taxes) and retained earnings in the 

early postwar period are obviously subject to an exceedingly wide range 

of error. No attempt has been made to resolve all the uncertainties involved in the broad assumptions made on such component factors as 

prices, wage costs, and taxes. Rather, an effort has been made to arrive 

at a fairly reasonable set of figures on retained earnings as a source of 

funds for business expansion. It should be noted, however, that the component factors are to a considerable extent interrelated, and that the 

course of developments in individual factors may be influenced considerably by the net results of their combination. More specifically, managerial 

policy will tend to seek such prices for industrial output as will yield a 

"legitimate" profit, while organized labor will in turn refer to the size of 

profit increases as a guide to its demands on wage rates. There is also 

some reason to think that dividend policies will be influenced by the need 

for funds for expansion, as well as by current net profit levels. 

These considerations were borne in mind in working out the projections 

shown in the table. It will be observed that the level of net profits in 

1948 (annual rate) is projected at 50-60 per cent above that of 1945 in 

the metal products group and the petroleum, chemicals, and rubber industries, and about 100 per cent above the 1945 level in "all other" industries. Owing to the more rapid increase in dividend payments in 

1948, however, the amount of profit retained in 1948 (on an annual 

basis) is presumed to be about the same as in 1946-47. 

The extent to which funds may be provided from internal sources in 

another manner—through revenues to cover charges for depreciation and 

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MANUFACTURING AND MINING INDUSTRIES 31 

amortization on existing plant and equipment—is illustrated in the accompanying table. Regular allowances for depreciation may total 9.5 

billion dollars in the three and one-half year period 1945 to mid-1948, 

and the final amortization of war plants may result in another 1.9 billion. 

The extent to which capital expenditures on plant and equipment may 

be financed from this internal source of funds is brought out in the table, 

which also shows the capital expenditures projected for the three and 

ELEMENTS OF ESTIMATED CHANGE IN NET PROPERTY, END OF 1944 TO MID-1948 

Broad Industry Groups of Manufacturing and Mining Corporations 

(In billions of dollars) 

Net property, end of 1944 

Changes, 3i years to mid-1948: 

Plus: Capital expenditures 

Less: Allowance for depreciation1, etc.... 

Accelerated amortization of war 

plants 

Net increase 

Net property, mid-1948 

1

 Includes regular amortization of war plants for first nine months of 1945. 

NOTE.—Net property represents gross property (excluding intangibles) less accumulated reserves for depreciation, depletion, and amortization. The net tends to be increased by capital expenditures (for replacement as 

well as for additions) and to be decreased by current additions to reserves. Ordinary retirements of plant and 

equipment do not affect net property since they involve offsetting reduction in both gross property and reserves. 

Net property, end of 1944, derived as described in note to table on p. 20; capital expenditures from table on p. 

16; allowance for depreciation based on annual allowances as published in U. S. Treasury Department, Statistics 

of Income for 1942; accelerated amortization of war facilities estimated. 

one-half years and the resulting increase from the end of 1944 to the 

middle of 1948 in the property account (net of reserves for depreciation, 

depletion, and amortization). This change represents the extent to which 

funds for expenditures on plant and equipment would need to be drawn 

from retained earnings or external sources. The proportion of capital 

expenditures to be thus financed would be smallest (less than 40 per cent) 

in the metal products industries, in part because of the large amount 

set aside for amortization of war facilities, and largest (nearly 60 per cent) 

for the petroleum, chemicals, and rubber group. 

All manufacturing 

and mining 

27.5 

23.1 

9.5 

1.9 

1 11.6 | 

39.1 

Metals and 

products 

8.8 

7.5 

3.5 

1.3 

2.7 

11.5 

Petroleum, 

chemicals, 

rubber 

9.1 

8.7 

3.1 

0.5 

5.1 

14.2 

All other 

9.6 

6.9 

2.9 

0.2 

3.8 

13.4 

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32 PRIVATE CAPITAL REQUIREMENTS 

Indicated Need for External Financing. The factors in the postwar 

outlook which have been reviewed thus far provide the basis for a preliminary indication of business requirements for external financing. The 

need for funds has been suggested largely in connection with the projected 

capital expenditures, the projected increase in inventories and trade 

receivables, and substantial payments of income taxes as current accruals 

decline from wartime levels. Some of the funds could be obtained by 

drawing down holdings of liquid assets, and a good deal more is likely to be 

provided out of current operations, as retained profit and allowances for 

depreciation, depletion, and amortization. The net effect of these various 

elements in the outlook projected here is shown in the table on p. 33. 

The summary brings out major differences in these elements among the 

three broad industrial groups which have been analyzed separately 

throughout this paper. While the distribution of capital expenditures on 

plant and equipment will be fairly evenly divided among the industry 

groups, the relative demand for funds, other than regular depreciation 

allowances, to meet this expansion will be greatest in the petroleum, 

chemicals, and rubber group. Relatively larger depreciation allowances 

will be an important factor in the other groups, augmented in the metals 

and products group by final amortization of war plants. Funds needed 

to meet tax payments as current accruals decline from wartime levels 

will be largest in the metals and products group, where war taxes were 

highest; correspondingly the drain on liquid assets as Government securities are used to finance tax payments will be the greatest in this industry 

group. Financial needs for the purpose of building up inventories and 

receivables will be greatest in the "all other'' group, which includes 

industries producing for nondurable civilian needs. 

In view of the range of error to which the projections are subject, the 

smaller changes from the end of 1944 to mid-1948 are of doubtful significance. The over-all picture which is focused on the larger changes may 

be presented briefly as follows (in billions of dollars): 

Metals Petroleum, .,, 

and chemicals, J$L„ 

products rubber

 othe r 

Funds required: To increase net property and retire Govern- 8 6 

ment liabilities .. . 10 

To increase net property and inventories.. 

Source of funds: Earnings and reduction of liquid assets 10 2 8 

Implication: Excess of funds available 2 

Net outside financing needed 4 2 

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MAJOR ELEMENTS IN PROJECTED NEED FOR EXTERNAL FINANCING 

END OF 1944 TO MID-1948 

Broad Industry Groups of Manufacturing and Mining Corporations 

(In billions of dollars) 

Balance sheet item 

Liquid assets 

Inventories and receivables.. 

Net property 

Other assets 

Total assets. 

Accounts payable 

Income taxes and Govt, advances1 

Other current liabilities2 

Reserves and surplus 

B alance: outstanding 

stocks, bonds, and 

notes payable3 

1944 1948 Change 

!All manufacturing and mining 

25.0 

35.4 

27.5 

13.8 

101.6 

8.2 

12.5 

5.2 

35.0 

40.6 

16.4 

42.0 

39.1 

14.2 

111.7 

10.0 

5.6 

4.6 

47.5 

44.0 

-8. 6 

+6. 6 

+ 11.6 

+0. 4 

+10. 1 

+1. 8 

-6. 9 

-0. 6 

+ 12.5 

+3.4 

1944 1948 

Metals and products 

12.6 

17.8 

8.8 

4.2 

43.3 

3.6 

7.4 

3.2 

15.6 

13.5 

7.5 

17.5 

11.5 

4.3 

40.8 

4.0 

2.5 

2.5 

20.6 

11.2 

Petroleum, chemicals, rubbed 

Liquid assets 

Inventories and receivables. 

Net property 

Other assets 

Total assets 

3.7 

5.9 

9.1 

4.4 

Accounts payable 

Income taxes and Govt, advances1 

Other current liabilities2 

Reserves and surplus 

B alance: outstanding 

stocks, bonds, and 

notes payable3 

23.1 

2.4 

1.7 

0.5 

7.3 

11.1 

2.5 

6.4 

14.2 

4.4 

27.5 

2.0 

0.7 

0.6 

9.0 

15.2 

-1. 2 

+0. 5 

+5. 1 

8.7 

11.7 

9.6 

5.2 

All other 

6.4 

18.1 

13.4 

5.5 

+4.4 

-0. 4 

-1. 0 

+0. 1 

+ 1.7 

+4. 1 

35.2 

2.2 

3.4 

1.5 

12.1 

16.0 

43.4 

4.0 

2.4 

1.5 

17.9 

17.6 

1

 Includes Government advances at end of 1944 as follows: metals and products, 1.5; petroleum, chemicals, 

rubber, 0.2; all other, 0.1 billion dollars. 

* Excludes notes payable to banks. 

• Includes notes payable to banks at end of 1944 as follows: metals and products, 2.0; petroleum, chemicals, 

rubber, 0.7; and all other, 1.4 billion dollars. 

NOTE.—Figures for 1944 are derived as described in note to table on p. 20. Projections for 1948 are drawn from 

preceding tables as follows: liquid assets and inventories, p. 20; receivables, p. 24; net property, p. 31; accounts 

payable, p. 24. Income taxes and other current liabilities are as described on pp. 23-24 and 30; data for reserves 

and surplus are adjustments of retained earnings 1945 to mid-1948 as given on p. 29. The small increase in "other 

assets" (representing intercorporate investments and some intangibles) is a rough allowance for the acquisition 

of new subsidiaries, an item which has been reported on an increasing scale since the war. 

Details do not always add to totals because of rounding. 

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34 PRIVATE CAPITAL REQUIREMENTS 

This summary indicates that the metals and products industries, as a 

group, will not need outside financing, but a fairly large amount of outside 

financing will be needed in the petroleum, chemicals, and rubber group, 

and a relatively small amount in the "all other" group. Whatever may be 

the margin of error in these separate estimates by broad industry groups, 

they illustrate the fact that, from a practical standpoint, the need for 

financing by several companies examined individually is generally much 

greater than the net need for the group treated as a unit. Thus, in the case 

of the three broad industrial groups analyzed in this paper, the outside 

financing indicated for two of them totals 6 billion dollars as compared to 

only 4 billion for manufacturing and mining in the aggregate. 

It is not easy to say what these figures mean in terms of the available 

statistical series on bank loans to business and new security issues. As 

regards the increase in outstanding bank loans, available statistics are 

net in that new loans are partly offset by retirements of old loans. Available series on new security issues, however, are gross, that is, they are not 

partly offset by security issues retired for cash. Accordingly under the 

mixed liquidity conditions envisaged above for the early postwar years, 

"security issues for new money" might come to two or three (or more) 

times the net amount of funds actually absorbed from the market by 

industrial concerns in the aggregate. 

In view of these considerations, it seems not unlikely that a net outside 

financing of 4 billion dollars might correspond to cumulative new security 

issues plus a net increase in bank loans approaching 8 to 12 billion dollars. 

If this amount, entailing an annual average of 2.5 to 4 billion a year, 

should be obtained by industrial companies alone, it would be larger than 

in any similar period during recent years. 

In view of the generally tenuous basis on which the indicated needs 

for outside financing were reached, there would seem little point in 

attempting to go further and to suggest how much of the financing might 

be done by banks and how much through sale of new securities. For all 

companies in the aggregate there may be little basis for expecting either 

source to provide the major part of the needs. Judging from past experience, large companies may perhaps rely more on the security markets 

than on banks, while medium-size and small companies may rely more on 

banks. Even this guess may prove incorrect if the wartime accumulations 

of individual savings should induce private investors to become more 

interested in small businesses, and if banks should continue to adapt 

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MANUFACTURING AND MINING INDUSTRIES 35 

loan terms and interest rates to the varied needs and credit standings 

of companies of different size. 

In the event that the Federal Government should become increasingly 

interested in nurturing small business as a vital element in the economic 

and social structure of the United States, more credit might be directed 

into the smaller concerns, even as the financing of agriculture was promoted by the Government directly and indirectly during the 1930's. 

In this connection it may be recalled that, in discussing the purchase of 

Government owned war plants, it was assumed that half the amount 

purchased might be financed by Government credit on an instalment 

basis. In the metal products group, where the analysis indicated an overall plethora of funds, Government credit would presumably be used mostly 

by small- or medium-size concerns interested in undertaking relatively 

large expansions. In the petroleum, chemicals, and rubber group, where 

the postwar need for outside financing appears to be greatest, Government 

credit might be a relatively minor factor owing to the smaller volume of 

Government plant facilities suitable for purchase. 

LIMITATIONS OF ANALYSIS AND SOME GENERAL CONCLUSIONS 

In the present review of postwar capital needs of manufacturing and 

mining industries and their financing, an attempt has been made to 

project the wartime financial experience of industrial business as far as 

possible quantitatively. In doing so it has been pointed out repeatedly 

that the projections are necessarily based largely on assumptions. On 

some points past experience may be so definite as to justify the assumption 

within fairly narrow limits, and on other points the assumption may 

represent a reasonably informed guess; but in a number of essential 

respects there is at present little basis for reaching an informed judgment. 

These limitations are inherent in almost any set of economic projections 

into the future. Their effect becomes magnified when the projections 

involve as complex a subject as the financial position of business, and when 

interest is focused on an item—outside financing—which is determined as 

a residual from the various changes in other factors. 

In such a situation one may well wonder what useful conclusions can be 

drawn from the analysis. Without trying to place too much weight on the 

quantitative aspects of the picture, three important conclusions seem 

supportable: 

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(1) There will be a fairly large need for new industrial facilities after 

the war, even in the metal products industries where most of the Government financed war plants are located. 

(2) Corporations are likely to reduce substantially their holdings of 

liquid assets in order to finance expansion of other assets. 

(3) In the industries where expansion of plant and equipment and 

inventories is largest, considerable outside financing will be needed. 

The significance of the first and third of these points is suggested in the 

opening paragraphs of this paper. The reduction of liquid asset holdings, 

the second point, has particular significance when viewed from the standpoint of the economy as a whole. If businesses in the aggregate should 

reduce their Government security holdings without an attendant contraction in the total publicly held Government debt, individuals and financial 

institutions, particularly banks and insurance companies, would have to 

increase their investment in Government securities. And a reduction in 

business balances of cash (currency and bank deposits) would entail an 

increase in cash holdings of individuals. This would come about through 

businesses making pay roll and other disbursements to individuals for 

producing goods which do not enter consumer markets, that is, for 

inventories, plant construction, and equipment. 

The important question arises how much consumers would then be 

willing to add to their holdings of Government securities and of cash. 

Would they be willing to absorb as much as businesses spend for increasing assets, or would consumers tend to increase spending pressures, and 

thus turn some of their funds back to business concerns in the form of 

much higher profits? 

These questions suggest how certain crucial aspects of the postwar 

national economy can be illuminated by further analysis of business 

finance. And it is hoped that the analysis presented in this paper may 

challenge others to go ahead with the many studies and investigations 

which seem prerequisite to the framing of more adequate assumptions 

and projections. 

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LONG-TERM NEEDS OF SMALL BUSINESS 

by 

ERNEST J. HOPKINS 

Division of Research and Statistics, Board of Governors 

A concrete program for enabling the numerous small and independent 

business firms to attain greater economic health is a primary need, not 

only of small business, but of the national economy, in the postwar 

period. 

There exist today within the business structure, in spite of the concentrative trends of the past half-century or more, approximately 3 million 

individual enterprises that represent diffusion rather than concentration 

of economic activity. Numerically, these are well above 90 per cent of all 

business firms. Their significance is not only economic but socio-economic 

and social. As far as production is concerned, these relatively atomistic 

units account in the aggregate for about one-third of total sales in the 

trade, service, construction, and manufacturing divisions of business. 

Owing to their prevalence in those types of production that emphasize 

the human more than the mechanical element, their employment of labor 

is more nearly one-half than one-third of all employment in these lines. 

Qualitatively their economic work is an essential part of the concert of 

production, for in adjusting themselves to life in a land of business giants 

the smaller units have increasingly specialized in those detailed and 

variable tasks, demanded by particular case business markets and more or 

less local consumer markets, that are not especially amenable to mass 

production methods and resist the standardizing techniques. Their influence upon the variety of the standard of living and the character of 

communities accordingly is an intimate one. 

Broader values are those of the order of economic life that is the 

derivative of multi-unit enterprise. The status of small business is in 

large part the measure of the status of the competitive system. It is also 

the measure of the opportunity for personal enterprise and individual 

economic venturing for the man in business as distinguished from the 

ladder-like career of advancement within great organizations. Small 

business in brief is one of the main economic embodiments of individualism 

with all that it implies, and while obviously a vast range of economic work 

exists that is beyond the scope of individualistic performance, it may be 

37 

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38 PRIVATE CAPITAL REQUIREMENTS 

for that reason that a somewhat special value attaches to that portion of 

the economy that interposes a resistance to increasing concentration and 

enables the institutional values of individualism to maintain and perpetuate themselves. 

As matters stand, the man in business abundantly persists, but does so 

under the pressures of an unfavorable and neglectful business environment. The "small business problem," or complex of problems, is far from 

new; it has had both a traditional and a modern stage. Traditionally, 

the problem centered upon the rigors and hazards of unbridled competition and of the helter-skelter venturing of the period of laissez faire. 

The problem in its more modern aspects presents a diminution of those 

rigors, but has new elements arising from the increasing spread of business 

size: what was formerly the "business" is now the "small business"; 

what was formerly an economy of independent ventures is now an area in 

an economy where highly organized and "established" big businesses 

predominate. Thus competition includes size competition, and the 

"satellite" or subsidiary position has entered with the increasing arrangement of firms of different sizes in concatenations or tiers of production. 

The twin problem of the smaller unit is not only that of possible competitive absorption or extinction, but quite as much that of unilateral bargaining, domination by the great concern with which it vertically deals, 

pseudo-independence. The individualistic area of the economy finds its 

individualism not gone, but seriously qualified in the modern world. 

Two avenues of approach exist for attacking this broad situation. The 

first, namely the attempted break-up of large monopolies, has been a 

feature of national policy for many years, with results that have been 

conditioned by the fact that a great deal of modern production is possible 

only through large-scale technology. It is an implication of this policy 

that small business will expand of its own power if given a chance, and 

this implication is valid; independent minded individuals do continue to 

show an apparently undiminished proclivity to volunteer for those 

economic tasks of which they are capable, and the resilience of small 

business after its recent setback during the war is being demonstrated 

today by the founding of new small enterprises at what may be a record 

rate. The second approach is the application of economic planning, public 

and private, to the environment in which the small businesses, new or old, 

must live. That environment should include a full quota of institutional 

aids, favorable for the small units as well as for the large. 

Since the present study is focused on this second approach, the general 

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nature of such a program may be briefly developed. A rounded attack is 

needed. Business enterprises do not live from their internal strength 

alone. The external aids and available facilities, whether economic, 

scientific, legal, statistical, advisory, or financial, count and count heavily. 

Big business is abundantly supplied with such aids; indeed, much of the 

rise and elaboration of the modern external aids to business was developed 

concurrently with the rise of the great productive enterprises and combinations, and as services to them. It is from this trend that the institutional aspect of the small business problem developed historically. The 

structure of business facilities and aids developed preferentially by 

business size, so that today small business lacks an access to the national 

body of business information and of business funds that is comparable to 

that enjoyed by the large corporation. Even the services of Government 

to business show a preferential character by size, paralleling the preferential emphasis of the private services. The general deficiency of normal 

business facilities for the diffused sector of the business economy, the 

smaller units, has been referred to, with some force, as an "institutional 

gap." 

The problem, concretely, consists in filling that gap. This is not, 

doubtless, the entire remedy for the problems of small business, but it 

presents the obvious initial attack. The existence of adequate facilities, 

geared to the peculiar structure and characteristic needs of small-unit 

enterprise, would go at least some distance in strengthening the hands of 

the individual entrepreneur in coping with his larger problems. Technological disadvantages, for example, would be reduced if technological 

information were readily available; an adequate flow of funds would do 

much to liberate the small units from those controls that result from 

restrictive and often locally monopolistic financing. The small business 

owner-management equally with the professional corporate management 

needs and is presumably entitled to the aids of the expert accountant, the 

business economist, and the business counsellor. When this is recognized, 

the difficulties of contacting the myriad small businesses and of adjusting 

the needed services to their particular characteristics begin. 

Certain broad requirements must be met. Primarily, the independence 

of the smaller units must be preserved; independent enterprise is not to 

be subsidized; it is not so much to be helped as enabled to help itself. 

The administrative problem is considerable: a two-level system, combining local and immediate contact points with access to the resources of the 

nation, is strongly suggested as the general plan. The problem is not 

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40 PRIVATE CAPITAL REQUIREMENTS 

purely financial, since questions of management, of legislation and law 

enforcement, of regional and local development, of taxation and of competition, are involved with those of finance. Perhaps the test of the success 

of a program of facility aids would be a financial test: namely the automatic revival of the interest of investors in the individualistic order of 

enterprise, which they traditionally financed in the past. But the various 

aspects of the entire complex of problems require concurrent attack along 

a broad front. 

Most needed of all, perhaps, is a more general recognition that small 

business has appropriate functions and an economic efficiency of its 

own, and that it is entitled to the means for playing its full potential part 

in the national economy. Economic science no less than Government and 

private enterprise has neglected this individualistic area of the business 

structure, and though progress toward an understanding of the sector has 

been made of late, the body of knowledge is still incomplete. A preliminary 

necessity is a better grasp of the facts about small business as a guide to 

the peculiar economic characteristics that a program of aids must reflect. 

To this factual survey the pages that immediately follow are devoted, 

after which the features and problems of the required program are 

discussed. 

THE MEANING OF "SMALL BUSINESS" 

The meaning of "small business" is to be described rather than defined* 

The relative adjective "small" refers, not to any specific size of business 

firm, but to the firm that is small in comparison to other firms with which 

it competes or deals. "Small business" in its aggregate sense refers to that 

portion of a given industry, an industry group, or of business as a whole, 

that is made up of relatively small and functionally individual units. 

But a broader meaning attaches to the term, less by definition than by, 

connotation. The phrase "small business" originated in popular parlance 

as an antonym of the term "big business," and its increasing acceptance 

in economics has not altered the suggestion that is conveyed. What is 

implied is an order of economic life, with distinct sociological implications, that is broadly associated with the lower extreme of business 

size. 

Attempted Statistical Definitions. Although there is no precise size at 

which the characteristics referred to can be said to disappear, various 

attempts have been made to delimit smallness in business at some fixed 

point, by one or another statistical measure of business size. While it is 

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LONG-TERM NEEDS OF SMALL BUSINESS 41 

convenient for purpose of analysis to segregate the lower size-brackets 

of statistical compilations and to study them separately, such segregation 

does not constitute a definition and should not be presented or understood 

as such. A danger exists that, through repeated usage for study purposes, 

some arithmetical ceiling upon smallness in business may become accepted 

as a definition and be cemented into law. Various bills introduced into 

Congress for providing aids to small business have contained such fixed 

limits, which would arbitrarily have restricted the application of the 

intended benefits and created unrealistically rigid discrimination among 

businesses by size. 

Qualification of the Statistics. The fallacy of attempts to define "small 

business" in fixed terms appears, first, when it is considered that no overall norm or benchmark of business size exists to which the relative 

adjective "small" can logically be compared. A second qualification is 

probably more important: there is no single measure of business size that 

correlates consistently with other measures, and there is no measure that 

does not reflect the immediate operative position of a business, which in 

actual life is a variable, as well as its fundamental size. 

The usual measures, because the most generally available, are the 

number of workers employed, the amount of annual sales or receipts, 

the value of total assets, and the net worth of enterprise. The ratios 

between these different measures vary according to the sub-type of business; 100-worker firms in trade, manufacturing, construction, service, or 

finance, for example, will have widely different sales. How sales fail to 

correlate with business assets is indicated by the fact that in 1939, for the 

smaller corporations, each $1.00 in capital assets produced $2.56 of gross 

sales in service, $4.08 in lumber manufacture, $5.61 in food processing, 

$7.92 in the construction industry, $11.28 in retail trade, $23.66 in wholesale trade, and $27.77 in apparel.1

 Net worth has only a vague relation to 

size in production; a large producing enterprise may have a small net 

worth. 

The same firm accordingly may have different size ratings by different 

measures. But also the size of a given firm, by any single measure, is likely 

to vary over a period of time. Size in employment changes with the market 

prospects, the availability of materials and funds, and other factors. 

So also does size as measured in sales. Total assets is perhaps the least 

variable of measures, but data are available only for the corporations, 

1

 Corporations with less than $250,000 in total assets. U. S. Treasury Department, Statistics 

of Income for 1939. 

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42 PRIVATE CAPITAL REQUIREMENTS 

which are about one-tenth of small businesses. The net worth of enterprise changes with the business financial position. Further, the inclusion 

in size statistics of affiliated establishments as well as independents harms 

the precision of measurements of the true small business sector. These 

qualifications, while they do not undermine the value for study purposes 

of the available data, nullify all attempts to fix a statistical ceiling as a 

rigid definition of small business. The Department of Commerce, in 

presenting $50,000 annual sales or receipts in retail trade, service, and 

construction, $200,000 annual sales in wholesale trade, and the employment of 100 workers in manufacturing, as the upper limit of business 

smaUness, is careful to use the term "understanding" rather than "definition." Less careful have been some analysts who, in following the annual 

statistical trends, have found that in times of rising prosperity the lower 

size-brackets of business decline in proportion to the whole, and have 

inferred that accelerated centralization of the economy was implied, 

whereas the rising cycle merely had placed many small businesses temporarily in a higher size-bracket. Conversely, in a time of decline, businesses 

of medium size may drop into a lower bracket, giving small business a 

false appearance of having flourished in recession. All in all, arithmetical 

definitions of small business are to be avoided, and in considering the 

statistics on the sector—including those that are presented in the present 

study—the foregoing qualifications are to be held in mind. 

Description of the Term. The meaning of "small business" is in any 

case, like the meaning of "big business," primarily to be sought through 

its implied qualitative characteristics. The smaller businesses, concretely, 

are the numerous one-man proprietorships, which are roughly four-fifths 

of all small undertakings; most partnerships, less than one-tenth of the 

number; and the family held or closely held corporations, more than onetenth. These small units have certain fairly common characteristics. 

Affiliates of larger companies are excluded by definition; the primary 

implication of "small business" is the one of business autonomy and 

independence. The ownership and the direct management of the small 

concern are generally identical, which is not true of large corporate 

enterprises; thus the term suggests the individual responsibility of the 

man in business. Most new enterprises are small and the element of venture in most small businesses is high; accordingly "small business" is 

virtually synonymous with venture enterprise, especially of the personal 

risk-taking type. Though local monopolies and product differentiation are 

not unknown, small businesses generally lack powers of market and price 

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LONG-TERM NEEDS OF SMALL BUSINESS 43 

control and are open to the invasion of competition; to identify them with 

"free and open competition" may be somewhat idealistic, but the term 

is generally associated with the concept of competition. Finally, the small 

units exist in great diffusion throughout the nation; in small communities 

they are often the mainstay of the local economy, and even in the larger 

cities they tend to provide the local type of business facility. Thus the 

term is closely related to the concepts and ambitions of community life. 

There is, finally, a psychological imputation, that of individual opportunity; one need not fully accept Alfred Oxenfeldt's view that the career of 

corporation employment and advancement develops a different type of 

person from the owner-manager of an independent small business but, 

as John M. Clark comments, "his statement. . .is a challenge to someone 

to prove it too simple."2 The American tradition is dichotomous, one 

powerful strain being an admiration of bigness for its own sake, an equally 

powerful and conflicting strain being localistic and individualistic; the 

term "small business" is linked to the individualistic branch of that 

tradition. Such are the various facets of meaning conveyed by the phrase. 

ECONOMIC MEASUREMENTS AND CHARACTERISTICS 

THE SMALL BUSINESS POPULATION 

Number and Distribution. The small businesses are extremely numerous. The table on page 44 shows the estimated total number of separate 

business firms at the beginning of the Second World War, distributed by 

major industries and by four subdivisions of size in terms of number of 

employees. Only 4,900 firms, or about 0.1 per cent of the total, had more 

than 500 workers. Of these few large enterprises nearly half were in 

manufacturing, public utilities and transportation concerns being second 

numerically and retail trade organizations third. 

Medium-size concerns, those with 50 to 500 employees, outnumbered 

the "large" group by nearly 10 to 1; even so, they were only 1.4 per cent 

of all firms in the nation. As in the upper group, half of these were in 

manufacturing. The proportions that were in construction, wholesaling, 

financial, and service activities were larger than in the topmost bracket, 

while those in retail trade and in transportation and public utilities were 

smaller. 

The group of enterprises having 4 to 50 employees would in most industries be accepted as small. This group outnumbered by 10 to 1 the 

2

 Alfred H. Oxenfeldt, New Firms and Free Enterprise, American Council on Public Affairs, 

1944, p. 5, pp. 111-19. 

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44 PRIVATE CAPITAL REQUIREMENTS 

two upper size-groups combined and included more than 16 per cent of 

all firms. Trade preponderated, retail and wholesale firms constituting 

nearly half the entire number; manufacturing assumed second place but 

accounted for less than one-sixth of the number. In other major industries 

the proportions were smaller. 

ESTIMATED NUMBER OF OPERATING BUSINESS FIRMS, 19391 

By Industry and Size in Terms of Employment 

(In thousands) 

Industry 

Total, all industries2 

Retail trade 

Service industries3 

Finance, insurance, and real estate 

Manufacturing 

Transportation, communication, and 

public utilities 

Contract construction 

Wholesale trade 

Mining 

All size 

classes 

3,316.7 

1,601.4 

638.7 

286.4 

214.2 

207.7 

202.1 

144.8 

21.4 

Size classification by number of employees 

0-3 

employees 

2,724.3 

1,384.2 

571.9 

240.1 

102.0 

180.3 

146.2 

91.4 

8.4 

4-49 employees 

539.9 

210.9 

62.4 

43.7 

86.0 

23.7 

52.7 

49.6 

10.9 

50-499 employees 

47.5 

5.7 

4.1 

2.5 

23.8 

2.8 

3.1 

3.7 

2.1 

500 or 

more 

employees 

4.9 

Source.—U. S. Department of Commerce, Survey of Current Business, May 1944, p. 12. Number of employees 

refers to paid workers only and does not include entrepreneurs or unpaid family workers. 

1

 Corporations that are subsidiaries of other corporations are counted separately, but they are very few in 

number. 

* Due to rounding, totals do not necessarily equal the sum of components. 

» Professional services omitted. 

Much the same distribution by industries is found in the "very small" 

group, consisting of firms with not more than three employees each, and 

in the majority of cases with none. This group was five times as numerous 

as the 4- to 50-worker bracket and accounted for 82 per cent of the total 

number of business firms. In this group the service category had the place 

second to trade, accounting for more than one-fifth of the total number. 

Finance assumed third place. 

The internal structure of the small business sector indicated in the 

two lower size-groups of the table is probably typical for a time of peace: 

in retail trade, virtually half of all small business; in the various services, 

one-fifth; in finance, which includes small banking, real estate, insurance, 

and brokerage, about 9 per cent; in the utility group (mainly local land 

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LONG-TERM NEEDS OF SMALL BUSINESS 45 

and water transportation),about 6 per cent; about 6 per cent, also, in the 

construction industry, and in manufacturing; smaller percentages in 

wholesale trade and mining. Whether this distribution has held good over 

a period of years is unknown; there has probably been a long-time shift 

toward trade and service, and away from manufacturing, in small business 

as a whole. 

Numerical Persistence of Small Business. The standard estimate of 

the business population for the years prior to the recent past is that of 

Dun and Bradstreet, Inc., whose records reach back to 1879. How complete are the earlier figures cannot be known, and the total is not distributed by size of firm. On the assumption that the smaller units must 

have accounted in the past for at least as high a proportion of all enterprises as they did in 1939, and that the fluctuations of business population 

from year to year accordingly reflect mainly the ebb and flow of small 

concerns, it can be said that the evidence indicates the numerical persistence of small business rather than the reverse. For the year 1900, for 

example, this source estimated a total number of 1,174,300 firms in the 

nation, which was 1.54 businesses for each 100 of the national population 

in that year; for 1935 the number of firms was 1,982,900, which was 1.56 

per cent of the population.3 These two years were the low points of the 

ratio of businesses to population for the present century prior to the 

recent war; the high points were the years 1925-29 inclusive, in which 

the ratio exceeded 1.8 per cent. In most years since the beginning of the 

century there have been between 1.55 and 1.70 businesses to each 100 of 

population. Upward movements of this ratio appear to have coincided 

with periods of business expansion, downward fluctuations with periods 

of recession, and with the Second World War. 

Some turnover of firms within the business population is of course an 

essential characteristic of the venture sector of the economy and part of 

the normal process of economic adjustment. New firms are constantly 

being established and existing ones passing out of existence. The turnover 

rate, however, varies. Recurring to the Department of Commerce figures, 

this turnover is recorded as having been exceptionally high since 1939.4 

Many small firms went out of existence in response to wartime conditions; since the end of hostilities many new firms have been established. 

8

 U. S. Department of Commerce, Statistical Abstract of the United States, 1944-45, pp. 8, 

397. 

4

 Howard R. Bowen, Donald W. Paden, and Genevieve B. Wimsatt, "New and Discontinued Businesses, 1940-43," Survey of Current Business, July 1944, pp. 7-14. 

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46 PRIVATE CAPITAL REQUIREMENTS 

During 1940 and 1941 existing firms were discontinued and new firms 

established in roughly the same numbers—about 11-13 per cent of the 

total number. This, perhaps, was not far from the normal turnover for a 

period of prosperity. But with the emphasis upon war production and the 

increased absorption of men in war employment and in the armed forces, 

the number of discontinued firms sharply increased, while the number of 

new firms fell off. By 1944 the total business population accordingly had 

declined by 15 per cent. A sharp revival brought the business population 

by the end of 1945 to 3,234,800 firms, or within 3 per cent of the number 

at the end of 1941. 

There has been a tendency to ascribe business discontinuances to 

the deficiencies of small business management. This is a superficial explanation; the influence of the business environment is obviously an important factor, whether as to general conditions affecting earnings, as to 

the launching of new firms without adequate opportunity surveys or other 

economic information, or as to lack of external advisory and financial 

support that would reduce the discontinuance rate. 

EMPLOYMENT IN SMALL BUSINESS 

Small business is engaged in types of production that rely upon 

manpower and light equipment rather than heavy fixed capital. Before 

the war an estimated 10 million persons, including 8 million wageearners and over 2 million active proprietors, derived their livings from 

the 3.3 million enterprises in the lower size-brackets in the table on page 

44.5 Another and more conservative set of measures of smallness currently 

used in the Department of Commerce and presented in the table on page 

47 shows how some 8.4 million workers and proprietors were distributed 

among five major industry groups of very small business in 1939, and how 

this employment compared with total employment in those groups. 

As the table shows, these very small units in 1939 accounted for a little 

more than one-third of the total production in the five industry groups 

that are included, but in so doing employed 45 per cent of the total manpower in those industry groups. Yet their average employment was 

only three persons each. Retail trade concerns with an average of little 

more than two active workers (proprietors included) contributed a total 

employment of nearly 3.5 million. Service concerns of similar size employed more than 1.5 million persons. Construction firms, averaging 

three persons each, provided more than 600,000 jobs. Small manufactur6

 Donald W. Paden, "Industrial Concentration of Employment," Survey of Current Business, April 1945, p. 10. 

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SMALL BUSINESS AND NATIONAL TOTALS COMPARED, 1939 

NUMBER OF ESTABLISHMENTS, NUMBER OF ACTIVE WORKERS, AND VALUE OF OUTPUT, IN FIVE MAJOR 

INDUSTRY GROUPS 

Industry 

Retail trade5 

Service6-

7 

Construction 

Manufacturing7 

Wholesale trade 

Total 

Number of establishments1 

Total 

1,770,355 

718,932 

215,050 

184,230 

92,794 

2,981,361 

Small 

Number* 

1,614,310 

703,160 

200,299 

168,814 

71,681 

2,758,264 

Per cent 

91.2 

97.8 

93.1 

91.6 

77.2 

92.5 

Number of active workers2 

Total 

6,210,788 

2,373,785 

1,300,439 

7,886,567 

912,548 

18,684,125 

Small 

Number4 

3,487,984 

1,551,548 

610,740 

2,358,968 

355,731 

8,364,971 

Per cent 

56.2 

65.4 

47.0 

29.9 

39.0 

44.8 

Value of output8 

Total 

$42,041,790 

5,281,651 

4,519,794 

56,843,025 

19,418,547 

128,104,807 

Small 

Number* 

$17,836,171 

2,803,709 

1,546,275 

17,366,698 

4,100,404 

43,653,257 

Per cent 

42.4 

53.1 

34.2 

30.6 

21.1 

34.1 

Source.—Data submitted by the U. S. Department of Commerce and later published in Small Business and the War Program (Hearings before the Special Senate Committee to Study and Survey Problems of Small Business Enterprises, Dec. 18, 1941), Pt. 1, p. 292. Footnotes 2-4 and 6 have been modified slightly, and footnotes 1, 5, 

and 7 have been added. 

1

 Number of establishments shown in this table differs from number of firms shown in the table on p.44; a firm, and especially a large one, may include several establishments, and establishments of large firms may be small. Firms with more than one establishment are probably most numerous in manufacturing. 

* Proprietors included in all groups except manufacturing. 

» Net sales in retail and wholesale trade, net receipts in service and construction, value of product in manufacturing. 

* Retail, service, and construction establishments with less than |50,000 annual net sales or receipts; wholesaling establishments with less than $200,000 annual net sales; 

manufacturing plants with not more than 100 employees. 

* Includes chain stores as follows: 123,195 establishments, of which 76,410 were small (sales under $50,000); 1,118,374 active workers, including 247,086 in small stores; $9,105,-

825 sales, including $1,783,289 in small stores. 

* Hotels and amusements included. 

? Manufacturing establishments with annual receipts of less than $5,000 are classified as service. 

I 

O 

i 

H 

H 

W 

O 

w 

O 

W 

d 

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48 PRIVATE CAPITAL REQUIREMENTS 

ing establishments, with an average (proprietors omitted) of fourteen 

wage-earners, accounted for nearly 2.4 million jobs.6 Wholesale trade, 

though not a small business stronghold, provided 350,000 jobs in units 

averaging five workers (proprietors included). 

How great was this contribution of small business to employment, in 

comparison to the proportionate value of the output of the small firms, 

is seen in the percentages of the table. In retail trade these small independent establishments, in making 38 per cent of the total sales, employed 

52 per cent of the total manpower in trade.7 In the service industries the 

small businesses enjoyed about 53 per cent of the total receipts and provided about 65 per cent of the total employment; a high reliance upon 

manpower is characteristic of this industry group as a whole. In the construction industry the small business share of 34 per cent in the total 

production involved the employment of 47 per cent of the manpower, 

while in wholesale trade the small firms, with 21 per cent of the total 

sales, utilized 39 per cent of the manpower. In manufacturing, as the 

table indicates, the small units had about a 30 per cent share in both 

total production and total employment, but these percentages are subject 

to qualifications, as will be later seen. 

This high factor of manpower in small business is one of its more important structural characteristics. It will be referred to in other connections, as it has significant implications to the problems of servicing and 

financing this type of enterprise as well as to the potential creation of 

employment through the expansion of the sector. A given amount of 

capital investment corresponds to more jobs in small business than in 

large. 

THE PLACE OF SMALL BUSINESS IN PRODUCTION 

An understanding of the part played by small business in the production 

of goods and services requires emphasis upon the qualitative aspects of 

that production. The data on page 47 tell only the quantitative tale. Such 

presentations often bring the comment: "Small businesses include more 

than 90 per cent of all enterprises, yet these have only about a one-third 

share in the total of production." The fallacy is in comparing incompa6

 The manufacturing figures are more greatly affected than those of the other groups by the 

inclusion of small affiliates of corporations. 

7

 In these ratios the small chain stores referred to in footnote 5 of the table have been 

excluded. 

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rabies; the output of bulk production and of the detailed forms of production and service are to a great extent unlike in kind. 

Primarily, the figures that appear to suggest a comparison between 

the output of small and large businesses actually reflect the size of different sub-industries, either supplementing each other by occupying different 

segments of the same production line, or totally unrelated to each other. 

To a considerable extent (though not, of course, entirely) the small and 

larger businesses are found active in different divisions of industry or at 

different stages of the productive process in the same industry. The output 

of retail trade, for example, cannot be placed in comparison with that of 

construction; it is equally incomparable to that of manufacturing. Within 

the construction industry, little basis of comparison exists between the 

building of railroads, dams, and bridges, and the surfacing of floors in 

homes; within manufacturing, the production of ingot steel is incomparable to that of women's hats. Even in specific industries, such as aluminum 

manufacture, the few large concerns that produce the primary product 

sell that product to smaller concerns that reprocess the aluminum; the 

output of the one becomes the raw material of the other. Thus small 

business and big business output, as reflected in their respective sales, 

cannot be validly compared. 

In brief, a considerable differentiation of function between small and 

large business exists. Something of this differentiation of function qan be 

indicated by a more detailed breakdown, by sub-industries, of the major 

industry figures of the table on page 47.8 Some of the reasons why small 

businesses are more appropriate to and prevalent in certain sub-types of 

activity also can be inferred. 

Retail Trade. In retail trade, direct competition among businesses of 

different size exists to a greater extent than in any other major group. 

As has been seen, 1.5 million independent small stores, which had in 1939 

less than $50,000 each in annual sales, accounted for 38 per cent of all 

retail sales. In five of the fifteen subdivisions of retail trade, however, the 

sales of the small independents far exceeded this percentage. Small stores 

accounted for about 90 per cent of the total sales of drinking places and 

filling stations, and for 70 to 80 per cent of all sales made by drug stores, 

eating places, secondhand stores, and food stores. In five additional lines 

the small independents had a more moderate but still substantial share, 

Data for this breakdown are from the Census of BusinesSj 1939. 

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ranging from 44 to 59 per cent of total sales; these were the hardware, 

apparel, liquor, general stores with food, and "miscellaneous" categories. 

These are lines in which the capital requirement is moderate, mercantile 

credit is sufficiently available, inventories are either of standard types or 

(in the case of apparel) capable of quality differentiation, and convenience 

of location and service to the consumer is a business advantage. 

In the four remaining subdivisions of trade—general merchandise, 

lumber and building materials, automobile products, and furniture, 

household goods, and radio—the capital requirement is higher, the cost 

of inventory greater, and the necessity to finance consumer accounts increases the requirement of working capital and credit. The role of the 

very small firms in these four lines accordingly was unimportant. 

Service. In this heterogeneous group, individual skill and personality, 

close adaptation to the consumer's varying wants and tastes, and convenience of location are in many cases the primary requirements of 

success. In service, accordingly, small business is at its height, very small 

units accounting in 1939 for more than half of the total receipts of all 

service enterprises. Subdivisions in which these small firms accounted for 

at least 95 per cent of all receipts included barber shops, hand laundries, 

cleaning, dyeing and pressing shops, shoe repair shops, metal smithies, 

watch and jewelry repair shops, radio repair shops, furniture repair and 

upholstery work, and beauty parlors. In general automobile and mechanical repair, their share was 90 per cent. Some of these are humble industries, 

yet their importance to the standard of living became evident when their 

services were scarce during the war. It is also evident that without the 

mechanical repair services to maintain mass-produced products after 

they reach the consumer, the automobile, radio, refrigerator, and electrical 

products output of big business could hardly exist. 

In many other of the 104 subdivisions of service the small establishments played a considerable part. But in the amusement industry the 

share of the small businesses in total receipts was minor, and the same was 

true of the hotel industry. 

Construction. The role of small business is even more specialized in the 

construction industry than in trade and service. One of the main divisions 

of the construction industry is that of the special trade contractors or 

skilled and semi-skilled artisans who are adjuncts to the construction 

industry in a wide variety of particular tasks. Nearly 45 per cent of all 

construction receipts in 1939 were in this division and the share of the 

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ing the units with less than $50,000 annual receipts did 90 per cent of the 

total volume of business, and in painting, paper-hanging, plumbing, 

plastering, installation of wooden flooring, sheet-metal work, excavating 

and grading, and house moving, their share was between 65 and 85 per 

cent. They also performed about half the total volume in roofing, heating 

installation, concrete work, masonry, tile and mantel work, and other 

such specialties. But in elevator installation and repair, and steel erection 

and repair, their shares were less than 10 per cent. 

The other main division, general contracting, which accounted for more 

than half of the industry's total receipts in 1939, is primarily heavy construction—highways, dams, tunnels, pipelines, railroads, and the like. 

In this work the small units play a negligible part. 

Manufacturing. The size limit of less than 100 active workers, used in 

the table on page 47, is extremely low for small establishments in manufacturing. The data, moreover, have other important qualifications that 

prevent accurate analysis of the place of independent small businesses 

in the 446 subdivisions of manufacturing.9 There are two ways, however, 

of indicating generally the place of small business in the 20 major divisions 

of manufacturing. The first is by considering the place of the small 

establishments or plants (irrespective of whether or not they are independent) in each division, and the second by considering the place of the 

independent establishments (irrespective of their size). 

By this combined test, two major industries, namely printing and 

publishing and apparel manufacturing, appear as preponderantly small 

business occupations. In 1939 the less-than-100-worker plants accounted 

for about 60 per cent of the total production in both these broad fields 

of manufacturing. The independents, small or large, accounted for about 

70 per cent of the output. There were 24,000 small plants in the printing 

and publishing industry, and 19,000 in the apparel group, and small 

branches of plural-unit concerns evidently were few. 

This was not the case, however, in the food processing industry, which 

included the largest number of small plants, 50,000. These plants accounted for 50 per cent of the entire production, but the existence of 

combinations in the food industries reduced the total number of 

9

 The Census of Manufactures, from which the data for this section are taken, includes 

some 34,000 affiliated or branch plants in its distribution of 184,230 manufacturing establishments by size. These cannot be segregated from the independent plants, as their size distribution is unknown. The Census subdivides the same 184,230 plants according to pluralunit and single-unit (independent) ownership, but this tabulation is not subdivided by size. 

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52 PRIVATE CAPITAL REQUIREMENTS 

independents of all sizes to 40,000, and their combined production to 39 

per cent of the total. 

Small business also played a considerable part in 1939 in three other 

main divisions of manufacturing, namely, furniture and finished lumber 

production, basic lumber, and, significantly, the "miscellaneous" group, 

which is fairly large. In all these divisions the small plants provided from 

42 to 53 per cent of the total production, while the independents of every 

size contributed approximately 60 per cent. 

In the chemical, textile, leather, machinery, and metal processing 

groups, small plants and also independent plants were numerous, but they 

were overshadowed as to quantity of production by the output of the 

medium-size plants and of the few large primary producers. To the primary producers the small plants generally have a "satellite" relationship, 

either as preliminary contributors to the bulk production or as reprocessors of the basic output. 

In the five most heavily concentrated divisions of manufacturing, 

namely, the transportation equipment, rubber, petroleum, automobile, 

and tobacco industries, the share of either the less-than-100-worker plants 

or of the independent plants was negligible. 

Factors determining the size of plant in a given manufacturing industry 

are many; what is most clear is that the manufacturing plant that is 

efficient for the given purpose is not necessarily large, and indeed the 

great majority of all plants are relatively small. Factors determining the 

existence of plural-unit ownerships are equally difficult to determine. 

It is to be noted that the value added per worker in manufacturing was 

higher in 1939 for the smaller establishments than for the larger ones. 

This probably reflects the types of sub-industry in which the smaller 

units are primarily engaged. On the other hand the average annual wage 

in proportion to value added declined with size, perhaps reflecting a 

greater engagement of the smaller units in seasonal industries and in 

industries with fluctuating markets and employment.10 

Other Activities. In wholesale trade the share of the smaller establishments is relatively minor. In finance, which is not included in the table 

on page 47, small firms are numerous, and these are especially important 

in providing the financing and brokerage services of communities. In 

1941, 63 per cent of the commercial banks of the nation had less than 

one million dollars each in deppsits. There are thousands of small real 

10

 U. S. Department of Commerce, Census of Manufactures, 1939, Vol. 1, p. 120. 

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LONG-TERM NEEDS OE SMALL BUSINESS 53 

estate, insurance, accounts financing, and personal loan companies of 

local scope. In transportation small concerns play an important part in 

local haulage, taxicab, and warehousing services. 

INTERNAL CHARACTERISTICS OF SMALL BUSINESS 

The purpose of the foregoing summary has been not only to indicate 

the quantitative share of small business in production, but also, by suggesting its qualitative place, to enable something of its internal characteristics to be inferred. Small business appears especially appropriate to 

certain types of work, in general the more detailed, special purpose, and 

variable lines of production and service. Its internal characteristics correspond to this order of task. They are, in general, the characteristics of an 

order of enterprise that represents flexibility in operation and adaptability 

to the particular market. 

High Sales-Capital Ratio. In virtually every major branch of business, 

the smaller the enterprise, the larger its dollar volume of sales in relation 

to its value of fixed assets. This internal characteristic of business 

smallness has at times been interpreted as under-capitalization. More 

properly it is to be regarded as a reflection of the intrinsic ability of the 

small entrepreneur to translate small amounts of capital assets into 

relatively large amounts of sales, or as a high element of "going-concern 

value" in the small business operation. This is demonstrated in the table 

on page 54, which classifies different types of business according to total 

assets and shows the ratios of annual gross sales to investment in capital 

assets for each size-group in 1939. 

For all types of corporate business combined, the gross sales of the 

smallest concerns in 1939 were nearly three and one-half times as large, 

for each dollar invested in capital assets, as the sales of corporations with 

total assets of 1 to 5 million dollars and nearly seven times as large as the 

sales of firms above the 5 million total assets mark. The rate of progression 

of the sales-assets ratio varied somewhat among the different industry 

groups and the subdivisions of manufacturing, but the general phenomenon was remarkably consistent throughout. Four factors combine to 

produce this statistical result. First, the smaller the enterprise, the more 

likely it is to be found in some sub-type of business that has a low capital 

and a high labor requirement. Second, in manufacturing especially, the 

small units often are found operating in the later stages of the serial 

process of production; their gross sales accordingly reflect the costs and 

profits of several preceding stages in production, as well as their own 

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GROSS ANNUAL SALES PER DOLLAR INVESTED IN CAPITAL ASSETS, 1939 

By Total Assets of Corporation 

Industry 

All corporations1 

Retail trade 

Wholesale trade 

Service 

Construction 

Mining, quarrying 

Utilities, transportation 

Manufacturing,2 All 

Automotive products 

Petroleum, coal products . . 

Tobacco products 

Rubber products 

Machinery, electrical 

Transportation equipment. 

Iron and steel products 

Nonferrous metals 

Machinery, non-electrical. 

Chemicals 

Textile mill products 

Paper 

Stone, clay, glass products. 

Leather and its products... 

Food products 

Beverages 

Printing and publishing. .. 

Apparel 

Furniture, finished lumber. 

Lumber and timber 

Size of corporation 

(Total assets, in thousands of dollars) 

Less 

than 

50 

50 

to 

100 

100 

to 

250 

250 

to 

500 

500 

to 

1,000 

1,000 

to 

5,000 

More 

than 

5,000 

Sales per dollar of invested capital 

$5.42 

13.16 

26.48 

4.47 

11.02 

1.56 

3.26 

6.64 

8.00 

10.00 

7.07 

6.54 

6.75 

3.00 

5.10 

7.75 

3.68 

4.43 

6.62 

6.60 

3.71 

20.67 

6.70 

3.93 

4.21 

29.13 

7.67 

5.38 

$3.32 

11.26 

23.90 

2.11 

7.15 

1.15 

2.03 

5.14 

5.00 

4.00 

7.74 

5.41 

5.80 

2.00 

4.00 

5.33 

3.30 

3.84 

5.60 

5.38 

2.60 

17.00 

5.47 

3.05 

3.24 

32.10 

5.38 

4.54 

$2.59 

9.33 

22.23 

1.58 

6.32 

.98 

1.46 

4.57 

5.29 

4.86 

7.75 

5.20 

5.75 

2.50 

3.84 

5.61 

2.85 

4.18 

4.32 

4.37 

2.29 

12.64 

5.23 

3.02 

3.12 

25.32 

4.34 

3.59 

$2.17 

7.40 

19.53 

1.18 

7.33 

.92 

1.13 

4.02 

4.50 

5.22 

5.43 

5.30 

5.93 

2.78 

3.41 

6.29 

3,09 

3.80 

3.60 

3.94 

2.06 

12.46 

5.30 

2.27 

2.79 

21.21 

3.96 

2.92 

$1.89 

7.07 

18.91 

.86 

5.97 

.84 

.72 

3.41 

3.33 

4.44 

6.50 

3.61 

4.24 

1.77 

2.95 

5.11 

2.91 

3.17 

3.21 

2.91 

2.03 

10.27 

5.15 

2.30 

2.28 

16.19 

3.35 

1.98 

$1.60 

5.83 

17.93 

.73 

5.06 

.60 

.45 

2.87 

3.77 

3.01 

4.54 

3.49 

4.59 

2.09 

2.75 

4.87 

2.82 

2.88 

2.59 

1.92 

1.24 

7.53 

4.41 

2.94 

2.11 

10.31 

3.16 

1.30 

Source.—U. S. Treasury Department, Statistics of Income for 1939. Capital assets include buildings, fixed and 

unfixed mechanical equipment, and certain intangible assets including patents, franchises, trademarks, goodwill, 

etc. 

1

 Includes following groups not shown separately: finance, insurance, real estate, and lessors of real property; agriculture, forestry, and fishery; and "other" (nature of business not allocable). 

2

 Includes "all other" group not shown separately. 

addition to value. Third, the smaller businesses often economize in the use 

of capital by renting rather than owning their quarters and at times their 

machinery, by occupying the less expensive locations, and by having 

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LONG-TERM NEEDS OF SMALL BUSINESS 55 

simple equipment with an avoidance of display. Fourth, the value of 

patents, franchises, and trademarks is relatively smaller for the smaller 

units. This characteristic lack of fixed assets is near to the heart of the 

credit problem of small business, since lenders often base credits upon 

"bricks and mortar" security rather than upon dynamic size. 

The Mechanical Equipment of Small Business. The prevalence of small 

business in lines of service, construction, and manufacturing that are of 

the light industry type has been noted. In these lines of production the 

small-unit type of mechanical equipment prevails. Such equipment is 

generally to be distinguished from mass-producing machinery by the fact 

that it exists in separate units rather than as part of a concatenated 

process; that it requires operative skill and hence is capable of product 

variation; that it is of the constant cost rather than the declining cost 

type; and that the capital outlay required for a single unit or a few units 

is relatively low. Examples are the stitching machines of the apparel 

industry, the linotype, the baking unit, the wood lathe and plane, the 

pattern making machines of the metal working industries. Such machines, 

precisely because they are designed for purposes other than the duplication 

of identical products, are as efficient for the purposes of variable production as any that are known. It is no accident that small enterprises persist 

in those types of enterprise in which the market calls for variability and 

small-lot "custom" specialization, for the technological basis is appropriate to such tasks and permits an efficient business unit to be small. 

Type of Efficiency of Small Business. Small business in general emphasizes the human and variable element in production while big business 

emphasizes the capital and repetitive element. It is customary, in this 

mechanical age, to speak of efficiency as though it were exclusively a 

matter of quantity output, of the duplicating or cost reducing order of 

production, and of uniformity in administration. Yet there is also an 

efficiency of adaptation, of flexibility, of the power and proclivity to vary 

that production; and this order of efficiency is exhibited by small business 

in many ways. The independence of its management liberates it from 

standardizing restrictions and "red tape," and substitutes the incentive 

of individualism. Its high labor factor and the adaptable unit machine 

render the small business capable of particular purpose tasks, of tasks 

that change from place to place and time to time, and of close response 

to the needs of small markets. The character of the machinery and equipment renders it possible to reduce or expand operations with relatively 

little effect upon unit costs. The small business, in short, represents 

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flexibility rather than the fixed commitment; and if its persistence in the 

economy has appeared to be in contradiction of standards of efficiency, 

established by a machine age, perhaps the standards should be extended 

to include the flexible and variable type of economic efl&ciency as well as 

the efficiency of repetition. 

Inferences to a Program of Aids. The major elements of the small 

business problem and the major premises of an attempted solution can 

now be inferred. 

The concrete purpose is to place at the disposal of the small unit enterpriser an adequate quota of those business facilities, nonfinancial and 

financial, that are required as normal operative needs for this type of 

enterprise. Such facilities must be formulated in terms of the fundamental 

characteristics of the type of business to be aided. Primary among these 

terms is the independent status of the small enterprise, which must be 

conserved, upbuilt, and, where it has been invaded, restored. 

The need for a strengthening of the operative efl&ciency and the financial 

position of the smaller units appears most clearly in their relationships 

to big business, whether those relationships are competitive with, or 

supplementary and ancillary to, the larger organizations. It is necessary 

to strengthen the hands of small business in meeting large-scale as well 

as multiple competition. It is equally necessary to strengthen its bargaining position when such bargaining involves units of very different size. 

In so doing, considerable inventive thinking is required. Administration must be such as to reach out to individual enterprises and to particular localities, yet also to provide a higher level access to the technical, 

managerial, and informational experience and to the financial resources 

of the nation. The business facilities must be provided in terms of the 

typical characteristics of small business itself, which differ from those of 

the larger enterprises in many essential respects. 

NONFINANCIAL PROBLEMS OF SMALL BUSINESS 

Underlying the financial problems of small business are certain nonfinancial problems that require solution as a prerequisite to, or concurrently with, the needed taxation, capital, and credit adjustments. 

The failure of the business environment to offer to the smaller units 

certain obvious nonfinancial facilities that are readily available to the 

larger organizations accounts in large part for the difficulties of the small 

business sector. Increasing perception of the importance of such facilities 

has resulted largely from earlier attempts to solve the small business 

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problem through financing devices alone. The slow loan, when inquired 

into by the banker, more often than not reveals the need of some one 

item of technological information, of some required information as to 

productive "know-how" or markets, or of some requirement for advice as 

to expert practices in management. When the information or advice is 

sought, it is often found not to be available locally, or indeed not available 

at all in a form that on the one hand is authoritative and on the other 

hand can be brought to bear upon the needs of the particular small concern. 

During the war the Smaller War Plants Corporation found it desirable 

to support its credits by services in matters of production technology. 

Since the war the Department of Commerce has reorganized and amplified 

its nonfinancial services to small business and now stands ready to provide 

small business with certain advisory and informational aids. Several 

types of need are involved. 

Need for Technological Information. In manufacturing, construction, 

and the mechanical services the isolated unit has difficulty in learning of 

the best and most modern scientific methods in production. Inability to 

maintain the rapid pace of technological advancement is hardly to be 

wondered at, since small business until the present time has had no 

central clearing house of such information. A vast body of technical and 

scientific information exists in the nation and is, indeed, one of our outstanding national assets; the problem is that of making this asset available to the smaller units wherever they are placed. 

Some information that would aid small business is protected by patent 

rights, or as trade secrets. But much that is of the highest quality remains 

available, in public and quasi-public hands, in the National Bureau of 

Standards, the National Research Council of the Academy of Sciences, 

the Federal and State research laboratories, the endowed research foundations, and the scientific departments of universities. The problem thus 

narrows to that of placing the individual small business that has a production problem in touch with the best source of advisory aid on that 

problem. 

In 1936 Mr. Bert H. White, a bank official of Buffalo, New York, who 

had been trained as an industrial engineer, found an ingenious answer. 

With the aid of the National Research Council he developed a file of the 

leading scientific authorities and other foremost sources of information on 

technical production problems, and offered the use of that file as a service 

to the industrial clients of his bank. Early in the war the system was 

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handed over as a patriotic service to the Smaller War Plants Corporation, 

which used it as an aid to improving war production in the smaller plants. 

The process was simple: upon encountering a technical production problem, the business firm would state that problem in a letter to its bank or to 

the SWPC; the list of leading authorities in the given field would be looked 

up in the file, and the query sent in duplicate to the entire list. Upon 

receipt of the replies, they would be summarized and sent to the querying 

enterprise, whose management could then select the most appropriate 

answers and correspond further with their sources as desired. Results 

proved valuable. Some 35,000 queries, involving about 6,500 different 

answers, were handled during the war by the SWPC. 

This service is now the Technical Advisory Service Division of the 

newly established Office of Small Business in the Department of Commerce. Its adaptation to the peacetime needs of small business on a 

permanent basis is a step in filling the "institutional gap." 

Need for General Management Advice. Inasmuch as the major asset 

of most small businesses is the intangible one of their ability to perform, 

the quality of their management is all important. Small business has had 

a reputation for mismanagement in the past, but has partly outlived that 

reputation; during the war many owner-managers made remarkable 

records of performance and expansion in unfamiliar fields. 

The task of small business management is not easy. The same individual 

is required to be equally competent in matters of production, sales, 

personnel relationships, customer relationships, accounting, financing, 

and the broader fields of labor and Government relations and the strategy 

of enterprise. The small business, moreover, must often meet the standards 

imposed by larger enterprises with specialists at their command. It is not 

by accident that many of the leading managers of large enterprises have 

undergone the training of small business experience. 

The improvement of managerial practices is a perpetual need, for 

which some facilities of course exist. There is an abundant literature upon 

management; schools of business are numerous; and local bankers, under 

the stimulus of the American Bankers Association, of late have been 

increasing their managerial aids to their smaller clients. That such aids 

to be effective must be supplied at the local level is the working principle 

of such organizations as the Louisville and Baltimore Industrial Foundations; local advisory services were recommended by the Small Business 

Committee of the Investment Bankers Association, and are a feature of 

the New York State program for fostering small business. Yet the local 

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aids need supplementation; talent varies, and the type of information 

needed by a given business may not be available locally. Into this gap 

the Department of Commerce also has entered, as will be described. 

Problems of Imperfect Competition. The individual instances of unfairness in competitive practice to which small business is subjected are part 

of a larger and more profound problem that cannot be adequately treated 

here.11 Small business is on the firing-line of this problem and not inconceivably might provide a medium through which the status of competition in the nation could be generally improved. One form that the problem 

assumes is that of inequitable direct competition between businesses of 

different economic power arising from difference in size; this is most 

familiar today in the field of trade, in which small business often finds 

itself in competition against the chain store and the department store; 

it also is found in other types of enterprise, though perhaps to a lesser 

extent. 

Under pressure of large-scale competition, the small business tends to 

survive by differentiating its product or location from that of the large 

competitor. At times also small business has supported legislation that 

has a bearing contrary to that of the unrestricted or "open" competition 

for which individual enterprise traditionally stands. This tendency, which 

has affected the laws of some States especially, has been forced upon small 

business by its necessity to protect itself against size competition and thus 

is part of the general problem. It is regrettable rather than remarkable 

that, under monopolistic pressures, the form of enterprise that conceptually stands for self-adjusting competition should at times adopt 

practices that are part of the problem of imperfect competition in 

themselves. 

Two affirmative approaches are conceivable: the general one of upbuilding the smaller units to a better operative position, and the special 

one of encouraging the small businesses to assist those law-enforcing 

agencies whose work it is to safeguard the nation against unfair competitive practices. Too often the "little man," when subjected to some unfair 

practice, has not complained. This has been a detriment to law enforcement in this field, but it may have been due to lack of contact with enforcement authorities, to a feeling that the minor instance of an illicit 

practice was not worth reporting, or simply to fear of the results upon 

existing business contacts. There are small business bureaus in the 

11

 See Howard S. Ellis, "Monopoly and Unemployment," in Prices, Wages, and Employment, 

No. 4 in this series. 

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Department of Justice, the Federal Trade Commission, and the Department of Commerce to receive complaints of this type. Services on the local 

level appear deficient. 

Problems of Unilateral Bargaining. When not in immediate competition 

against the larger business, the smaller one may be in a satellite or 

"vertical" relation in which it purchases products from, or sells products 

to, the large concern. The bargaining position of the small business in 

dealing with the larger enterprises is usually weak; such abuses as price 

dictation, restrictions of supply, "tie-in" sales, and other invasions of the 

independent status of the small enterprise, arise from this relationship. 

These too are part of the general problem of imperfect competition. 

Some of these abuses, for example those that involve control of sales 

practices and of the character of inventory by the trade creditor, would 

be subject to control if there were another and competing source of 

credit, for example, of cash credit. Other bargaining inequalities may be 

subject to control under existing law, or by new legislation, but again, 

as in the case of unfair competitive practices, the contact of small business 

with the law enforcing and legislative authorities has been deficient. 

Problem of Inadequate Information on the Small Business Area. 

Finally, much statistical and other information that is needed by small 

business and its advisors, and also by investors, economists, and others 

who desire to aid this form of enterprise, does not exist. Such information 

as to markets, for example, as is supplied in normal times to the exporter 

and to the agriculturist, is not compiled for the small manufacturer; 

and the statistical study of small business itself is in its infancy. There 

is need of much greater research into those types of information that small 

business specifically needs, and of much more adequate compilations of 

data about small business, if this sector of the economy is to attain a level 

of efficiency and to assume a place in financial and economic thought 

commensurate to its importance. 

The Department of Commerce Office of Small Business. To a large 

extent the problem of nonfinancial aids to small business may be summarized as a problem of communication. The individual small business, 

existing in isolation, has difficulty in making contact with the best 

scientific, managerial, and factual information of its time, and with those 

agencies, seemingly remote, that might enforce the law in its behalf. 

Financial, economic, and Governmental leadership, on its part, also has 

difficulty in reaching the small businesses, extremely numerous and 

extremely diffused as they are. 

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A system for establishing the needed channels of contact in both directions must, ultimately, operate as a two-level plan, combining the local 

and the national approach. As a step toward the formation of such an 

advisory and informational service, the Department of Commerce recently 

has consolidated its previous facilities for assisting small business, together 

with certain newly established services, into the new Office of Small 

Business. 

This Office, in recognition of the principle that whatever is done to aid 

independent enterprise must first and foremost recognize its independence, offers a query service, rounded in character, for small businesses 

to use of their own volition. The Office at this time of writing (early 1946) 

is just beginning to get under way; its status somewhat resembles that of 

the program of agricultural advisory aids when first projected. It is 

designed, however, to serve as a national clearing house for virtually any 

type of aid, other than direct financial aid, for which small business itself 

may call. 

Under the new organization a letter of query from a small enterprise, 

addressed simply to the "Office of Small Business, Department of Commerce, Washington, D. C." will bring to bear upon the particular problem 

the resources not only of the Office itself, but of those agencies within 

and without the Government that work in cooperation with the Office. 

The query is delivered, first, to the Business Counseling Division, which 

may either answer it directly or refer it to some special branch. This 

Division deals directly with business proposals and plans, selection of 

types of business into which an individual may enter, and budgets for 

proposed enterprises. It has separate subdivisions for considering the 

queries of war veterans and of nonveterans in these connections. 

If the query deals with trade opportunities, choice of locations, capital 

requirements, sources of funds, sources of supply, advertising, methods of 

financing, record keeping, pricing, or other matters of internal management, it is referred to the Management Advisory Service Division. This 

Division has separate subdivisions to deal with queries from retail trade, 

wholesale trade, manufacturing, and service establishments. 

If the query bears upon a scientific, technological, or other problem of 

"know-how" in production, it is referred to the Technical Advisory 

Service Division, which was transferred to the Department of Commerce 

from the Smaller War Plants Corporation in January 1946. 

If it bears upon problems connected with short-term credit, risk capital, 

or taxation, it is referred to the Finance and Tax Problems Division, and if 

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unfair trade practices are involved, it is referred to the Business Practices 

Division. Problems related to the industrial development of under-developed or economically unbalanced areas are referred to the Area 

Development Division, which is designed to work in cooperation with 

State and local planning boards and quasi-public developmental agencies 

for the strengthening of regional economies. Finally, there is a Special 

Services Division, to deal with matters not covered by the other Divisions, 

especially the relations of small business and the Federal Government, 

and particular case requests. 

It is too early to determine how this new Government set-up of advisory 

facilities will work out. Small business at all events now has a central 

contact point with the Federal Government. There appears to be a need 

for a greater development of the field division and of local small business 

advisory groups to handle on a decentralized basis those matters that can 

be locally adjusted and to work in cooperation with the Office of Small 

Business upon the local level. 

INTERNAL FINANCING AND TAXATION 

The first financial problem of small business to be considered is that of 

its internal financing. The crux of this problem is the effect of Federal 

income taxes, which in recent years have seriously reduced the volume of 

net earnings and consequently the self-financing ability of many small 

enterprises. Traditionally the growth of the small units has been financed 

internally through the "plowing back" of earnings. For this reason, perhaps, the demand for external funds of the type usually supplied by 

equity capital investment or long-term debt was not in the past the 

primary element of small business financing. 

With the marked increase in Federal income taxes in the past 15 

years, internal funds have become a less sufficient source of financing. 

Concurrently also, the ability to command external funds has been impaired by the effect of increased taxation on the financial position of small 

enterprises. Thus, it is to a considerable extent the tax situation that 

has brought the external financing problems of small business to the 

fore. 

Business income is affected by income taxes in several ways. The net 

income of the corporation is taxed, and then that portion distributed to 

stockholders is taxed again as individual income. Under the personal 

income tax the earnings of individual proprietors and partnerships, which 

comprise the great majority of small businesses, are taxed, as they accrue, 

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LONG-TERM NEEDS OF SMALL BUSINESS 63 

as part of the personal income of the individual. Under the latter arrangement business earnings, like any single source of individual income, are in 

effect taxed at the highest progressive rate that applies to the entire 

income of the individual. Earnings of unincorporated businesses are 

taxed at more sharply graduated rates under the individual income tax, 

while corporate profits are to some extent doubly taxed, first at the 

corporation level at less sharply graduated rates and second at the individual level on that part paid out as dividends. 

The immediate effect of high taxes on business earnings is to reduce 

the capacity of the business to finance itself through the plowing back of 

earnings. This fact is considered by the business manager, who is also the 

owner in the case of the unincorporated business, as he makes his plans 

for business expansion and the amassing of reserves. In sectors of business 

that characteristically have wide fluctuations in net earnings from year 

to year, retained earnings have also been subjected to wider fluctuations. 

Under progressive tax rates the income tax liability increases sharply in 

years when profits are high, and payment of the taxes in the following 

year, when earnings may be lower or the business may even be suffering 

a loss, may create a special hardship. The business creditor takes this into 

account in evaluating credit risk. Thus high income taxes contribute to the 

uncertain qualities of the credit risk of small businesses. 

An important mitigating element prior to the war was the fact that 

many very small businesses were not reached by the Federal income tax 

at all. The personal exemption of individual net income below $2,500 

for a married person and $1,000 for a single person kept outside the scope 

of the Federal income tax the business earnings of some 2 million individual proprietors, or about three-fifths of all small businesses. Under 

the lower exemptions currently in effect, $1,000 for a married person and 

$500 for a single person, a very much larger proportion of small business 

is reached; also at the present rates the individual pays higher taxes on his 

business profits than before the war. The situation is not to be interpreted 

as an adverse reflection on more extensive use of the income tax, at 

progressive rates, as a major source of Government revenues. What is 

emphasized, rather, is that such a trend should be accompanied by a 

growing consciousness of the special problems of the small entrepreneur 

and of the need for adjusting the necessarily heavy burden of taxation as 

nearly as possible to the distinguishing characteristics of the smaller 

units and the new ventures in the economy. 

Remedies directed to the major difficulties would include adequate 

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64 PRIVATE CAPITAL REQUIREMENTS 

recognition in the tax system of the often highly fluctuating earnings of 

the smaller businesses, by basing tax liability more nearly on the average 

level of earnings over a period of years; encouragement through special 

tax provisions of the amassing of the earned reserves upon which small 

business so fundamentally depends; and elimination of the inequities that 

arise from the differing treatment of incorporated and unincorporated 

businesses under the twofold system of income taxation. 

The fluctuating nature of business earnings was partially recognized 

for the years 1921-29 and again in 1939-41 through the provision that 

permitted both incorporated and unincorporated businesses to carry 

forward their losses from business operations as offsets against net income 

in the subsequent two years. The fluctuations were also recognized in 

carry-back and carry-forward provisions during the war years. It is 

believed that reinstatement of the prewar carry-forward provision for an 

extended period, say for five or seven years, would be justified in the 

case of small businesses so that income taxes would be determined on the 

basis of the average level of earnings. A more equitable adjustment 

of the income tax burden to the varying level of business profits would 

do much to provide a more reasonable volume of earnings for reinvestment 

and to strengthen the credit status. 

The tax laws, however, should go further and encourage the small 

business to build up a stronger basic financial position. At present business 

earnings are taxed whether they are to be used in the enterprise or not, 

with the exception (of relatively limited importance to small business) 

that the portion of corporate income retained within the business avoids 

double taxation under the income tax laws. 

A limited encouragement to the amassing of earnings for reinvestment 

purposes could be provided by allowing the small individual proprietor, 

in computing taxable income, to take a special deduction based on net 

earnings reserved for business purposes. Abuse of such a provision as a 

means of income tax evasion would, of course, have to be prevented. 

In order to limit the benefit to small business, it would be necessary to 

restrict eligibility for the deduction to businesses of a specified limited 

size, in total assets or in annual sales. Also, since the genuinely small 

proprietor is to be distinguished from the large investor who might seek 

to finance small business for the sake of the exemption, it would be necessary to restrict the deduction to the owner-operator whose business 

income provides a high proportion, say 80 per cent, of his entire income. 

The amount of the special deduction that could be taken by a bona fide 

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LONG-TERM NEEDS OE SMALL BUSINESS 65 

small business in a given year also should be limited in some manner, such 

as to a given percentage of the earnings from business (before taxes and 

the deduction), or to a certain percentage of regular depreciation charges, 

or perhaps to the building up of a total reserve not to exceed a specified 

percentage of total assets. 

The dual method of taxing business profits, depending on whether the 

business concern is incorporated or unincorporated, presents no problem 

for many small individual proprietors. For them earnings are either 

exempt from income tax or taxed at a relatively low rate under the 

personal exemptions and the low rate at the bottom of the progressive 

tax schedule. In some respects, however, small business would be benefited by the elimination of this dual system of taxation. First, the small 

business sector of the economy includes some corporations in addition to 

many individual proprietors and some partnerships. An equal treatment 

under the tax laws would be fairer to all small businesses. Second, the 

attraction of outside investor funds to concerns, small as well as large, is 

affected by the differing taxes on unincorporated versus incorporated 

earnings. 

The problem of the best over-all method of taxing business profits 

involves primarily the question of taxing corporate incomes and has 

implications for the tax system as a whole. It will not be considered here.12 

It may be noted, however, that as far as small corporations are concerned, 

a more equitable tax burden in relation to unincorporated businesses 

could be provided by permitting the stockholders to report for tax purposes in the same manner as the members of a partnership. 

Adjustment of the tax burden of small businesses to take account of 

their essential characteristics would contribute greatly to the solution of 

the financial problem of small concerns in other respects. 

PROBLEMS OF EXTERNAL FINANCING 

In a nation of abundant financial resources and of a private enterprise 

economy, it seems peculiarly ironical that small business should have 

complained for many years of deficient access to external funds. Record 

of this complaint exists from as early as 1910; since then it has been 

expressed in varying degrees and forms. That the situation of late has 

been taken seriously may be seen in the fact that 131 bills bearing on the 

12

 For a fuller treatment see Richard A. Musgrave, "Federal Tax Reform,'' in Public 

Finance and Full Employment, No. 3 in this series. 

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66 PRIVATE CAPITAL REQUIREMENTS 

problem were introduced into Congress in the period 1933-44,13 and that 

since the beginning of 1944 the leading organizations of commercial and 

investment banking have suggested various plans for opening up new 

avenues of external funds to small business. 

The plans have served to clarify the problem. There is, broadly speaking, a considerable agreement today as to the main elements of the situation. The difficulty is not that of quantity of needed funds. A minor 

fraction of the nation's savings would apparently suffice. Small business, 

although its capital requirements have increased with the increasing 

elaboration of machinery and equipment, is still, as the table on page 54 

indicated, a much lighter user of capital than is big business in relation 

to its production. Tending to reduce the demand is the fact that small 

business, like all businesses, finances itself wherever possible through the 

"plowing back" of its own earnings. But whether this is due to preference 

or to nonaccess to external funds is debatable. When small business voices 

a demand for external funds, it is likely to be an imperative demand. 

The problem, primarily, reflects an institutional gap in that it involves 

a form of risk-taking to which the existing structure and the prevailing 

standards and practices of the nation's investment and credit institutions 

are ill adapted. The reluctance of funds to flow into venture enterprise 

is the underlying problem. When the funds are institutional, and the 

ventures small and personal, this problem becomes more acute. 

Historical Basis of Problem. In previous times the individual local 

capitalist placed his funds directly on an ownership basis, in small but 

promising enterprises with which he was in touch. He shared their risks 

and profits outright, ordinarily not burdening them with hypothecation 

of assets, fixed charges, and debt obligations. His ally was often the socalled "personal" banker of the locality, who also supplied the seasonal 

and short-term credits. These two traditional figures were small business' 

appropriate financial source. 

Both have largely disappeared, the one in favor of the investor in 

securities of listed corporations and of Government, and the other under 

the influence of the modern objective standards of loan security and of the 

avoidance of risk in banking. The unsolved problem is that of their 

replacement. Various attempts have been made to devise some form of 

institution that will finance the fluctuating enterprises and ventures. In 

the years prior to the First World War, when the problem first began to 

18

 U. S. Department of Commerce, 390 Bills: a Digest of Proposals Considered by Congress 

in behalf of Small Business, 1933-1942," p. 13; 187 Bills, same subtitle, 1943-1944, p. 7. 

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LONG-TERM NEEDS OF SMALL BUSINESS 67 

emerge, some communities raised local funds to provide capital for local 

enterprises. About 20 such funds exist today and in some cases their work 

has been valuable, but the movement has not become general.14 A revival 

of this type of organization, with Government backing, was recommended 

in 1945 by the Investment Bankers Association of America.15 

An increasing number of the new small businesses started in the later 

1920's were financed in considerable part from big business sources, which 

needed new parts suppliers, outlets, and services. While a marked development resulted, the problem of the pseudo-independent or satellite small 

business also arose, and the danger of increased financial dependence of 

small business upon the large corporation was driven home. A current 

inheritance from the 1920's is the movement for the attainment of true 

independence by such enterprises, which is advancing especially among 

concerns engaged in the distribution of petroleum products. 

The depression of the 1930's not only drove venture capital into hiding, 

but also brought the external financing problem of small business to the 

acute stage where working capital supply was restricted. Lending concerns 

in search of liquidity terminated short-term lines of working capital 

credit, with resulting business discontinuances that added to the cumulative effects of the depression. Congress met this situation in part by 

inaugurating in 1934 direct financial assistance to private business through 

the Federal Reserve System and the Reconstruction Finance Corporation.16

 The assistance, limited to credits with maturities of not more than 

five years, and, in the case of the Federal Reserve, to working capital 

credits, took three forms: direct loans made by the agencies from their 

own funds; loans shared by them in participation with banks or other 

commercial lending institutions; and loans made solely by the private 

lenders with an agency's underwriting or guarantee. The amounts so 

loaned or guaranteed were not large, but provided relief in individual 

instances. A primary significance of the experience was in developing 

the guarantee or particular case insurance of commerical loans by a 

central underwriting agency. The guarantee emerged over an eight-year 

period as the best of the three forms of credit support, became the funda14

 Chamber of Commerce of the United States, Community Industrial Financing Plans 

(in mimeograph). Also, Ernest J. Hopkins, Th$ Louisville Industrial Foundation: A Study in 

Community Capitalization of Local Enterprises, Federal Reserve Bank of Atlanta, 1945. 

15

 Capital for Small Business: A Statement on National Policy by the Small Business Committee of the Investment Bankers Association. 

16

 Through the addition of Section 13b to the Federal Reserve Act and of Section 5d to the 

Reconstruction Finance Corporation Act. 

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68 PRIVATE CAPITAL REQUIREMENTS 

mental plan of the large-scale financing of war producers by the commercial banking system in the Second World War, and is the central plan 

advocated today for a lasting solution of the external financing problem 

of small business. 

The primary form of guarantee developed by this 12-year experience 

is the "take-out agreement" or "deferred participation." The commercial 

lender makes the original loan to a business with its own funds and 

services the loan throughout, but it does so under an agreement entered 

into at the start whereby at any future time the commercial lender may 

sell part of the loan to the central guaranteeing agency. If all goes well with 

the loan, the option to sell is never exercised, and the guarantee fee— 

stated as a portion of the interest rate on the loan, and paid by the bank 

as a premium for the contingent protection—goes into the central guaranteeing fund. But if in the commercial lender's opinion loss is threatened, 

or if the commercial lender desires to become more liquid, the lender 

exercises his option and the previously agreed-upon portion of the loan 

is bought by the central guarantor. Thus the "deferred participation" 

becomes an actual one, and from then on the loan is a partnership transaction between the originator and the guarantor, both the profits and losses 

being shared pro rata on the basis previously agreed. 

It may be observed that under this plan the central underwriter has 

a "pool of risks"; some individual transactions will make a return while 

others will incur a loss. This is fundamentally the principle of insurance, and it is regarded as the key to the institutional financing of business ventures which cannot be undertaken singly but can be undertaken in aggregates or groups; the larger and more diversified the better. 

There will be further discussion of this plan. 

In 1939-40, when the small business situation was investigated by the 

Temporary National Economic Committee of Congress, it was found that 

the restrictions of the 1934 legislation had prevented solution of the 

equity capital problem of small business, while the period of working 

capital shortage had contributed to a flourishing development of highcost lending institutions. The survey emphasized the need of a greater 

entry of commercial banks into the small business working capital field, 

also the need that banks should make long-term capital loans to small 

business.17 This finding caused controversy at the time, although commercial banks were currently increasing their term, loans to large bor17

 Temporary National Economic Committee of Congress, Problems of Small Business, 

(Monograph No. 17), pp. 276-77. 

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LONG-TERM NEEDS OF SMALL BUSINESS 69 

rowers, from an estimated 217 million dollars made in 1938 to an estimated 1,352 million made in 1940.18 

During the Second World War the financing problem of small business 

took the form of a lack of conversion and expansion capital for the small 

war producers. This was met in part through leases of equipment and 

direct cash loans by the Smaller War Plants Corporation to firms with 

less than 500 employees, and in greater part through the guaranteeing 

of commercial bank loan risks by the war procurement agencies through 

the agency of the Federal Reserve System under Regulation V of the 

Board of Governors. The arrangement for guarantee of loans under 

Regulation V drew on the commercial bank as the source of funds and 

reemphasized the effectiveness of a central guaranteeing plan behind 

credit risks in enabling bank credit funds to flow. The Smaller War 

Plants Corporation authorized 504 million dollars in loans and leases, 

all to small concerns. The V loan guaranteeing system authorized 10.3 

billion dollars in bank credit to war contractors of all sizes, and was an 

outstanding feature of the financing of war production. The large majority 

of borrowers were of medium size or small; loans authorized for firms 

having not more than $500,000 in total assets aggregated 835 million 

dollars up to March 31, 1945. 

Since the war, groups of the larger commercial banks have offered 

central protection to the smaller banks through a form of credit pool 

that offers outright loan participations rather than insurance type 

guarantees. Also, the Reconstruction Finance Corporation, backed with 

Federal Government funds, has offered a blanket guaranteeing plan, 

covering commercial loans up to 75 per cent of their face amount without 

individual examination of the risks, but with certain standard requirements. Neither of these differently limited central fund plans has been 

fully tested as yet. 

Central Principle of Solution. The experience summarized above points 

to the principle upon which current thinking centers as a permanent 

solution for the external financing problems of small business. It is 

generally agreed that direct Government lending to business, involving 

dangers of subsidization and of Federal invasion of private enterprise 

both in industry and finance, should be at most an emergency measure. 

Also it is generally accepted that the commercial banking system, with its 

14,000 outlets, its unparalleled ability to make contact with the smaller 

18

 Neil H. Jacoby and Raymond J. Saulnier, Term Lending to Business, National Bureau 

of Economic Research, pp. 2-3. 

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enterprises everywhere, and its abundant financial resources, would 

provide the best possible solution of the institutional difficulty if an 

adequate portion of its credit capacity could be enabled to finance business 

ventures. It has been well demonstrated that commercial banks will 

finance difficult and off-standard business situations if in so doing they do 

not jeopardize their responsibility to depositors and stockholders. The 

obstacles are mainly twofold: the need for a modification of credit 

standards, which are somewhat entrenched, and the necessity that the 

individual bank—primarily the smaller bank—be protected against undue 

loss of liquidity and undue financial risks on the credits it extends. 

There should be established, as a permanent feature of the commercial 

banking system, a central fund to be used for the underwriting or guaranteeing of business loans, particularly of those credits that an individual 

bank cannot extend if it must assume the entire risk. The deferred participation plan, which leaves the original lender free and utilizes his funds 

alone unless and until the transfer of risk is needed, should be the 

prevailing plan of operation of the central fund. The types of business 

situation financed, the relations between the guarantor and originators 

of the credit, and the percentage of risks contingently assumed by the 

central fund, should all be sufficiently liberal so that the risk margin of 

credit from institutional sources can be extended into the longer term as 

well as the short-term loans, into the area of small business, and into the 

financing of the important venture sector of business enterprise. 

This plan applies to both working capital and fixed capital needs of 

small business. It may be summarized from three points of view. From 

that of the business that needs external funds, the endorsement made by 

the central fund amounts to a supplementation of the loan collateral or 

other security that it can supply. From that of the lending institution, 

the security behind its loans is upbuilt, its liquidity is protected, and its 

earnings increased by "new business," which it otherwise could not 

undertake. From that of the central fund itself, a "pool of risks" is created, 

and the operation is essentially that of an insurance system, though less 

rigid than formal insurance. The plan is not new; its features have been 

tested in other connections; it merely requires adaptation as a permanent feature of the banking system. 

Application to Working Capital Credits. This plan applies, first, to credit 

for working capital purposes. Small businesses, as their high sales volume 

implies, are relatively large users of working capital. Those that need 

credit for financing their current operations obtain it at present from a 

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LONG-TERM NEEDS OF SMALL BUSINESS 71 

variety of sources. Despite the variety, the particular situation is often 

monopolistic; an individual small concern may have a single credit contact and be unable as a practical matter to shift to any other. What is 

most needed with respect to working capital is a greater competition 

among credit sources, as a control upon rates and upon credit practices. 

Also greatly needed is a firmer assurance against sudden reduction or 

termination of the credit, particularly in times of depression. 

The principal forms of working capital credit to small business at present are mercantile credit, extended to trade concerns by the suppliers of 

their inventories; cash credit, or the equivalent of credit, supplied by 

factors, finance companies, and small-loan companies that purchase 

accounts receivable at a discount; and lines of credit based upon accounts 

receivable as security, or short-term credit upon other security, supplied 

by commercial banks. The mercantile credit has the advantage of being 

directly related to the size of a business in volume of sales, rather than to 

its capital size. So also, within narrower limits, has the credit that is 

based upon customer accounts rather than upon the capital assets of the 

business. 

Problems in connection with these forms of credit arise at times when 

sufficient competition is absent. Thus, while mercantile credit provides 

most small retailers and wholesalers with inventory on a deferred-payment 

basis and is the mainstay of countless such concerns, its costs in individual 

cases are often concealed in the prices of commodities and are difficult to 

calculate; also, where no alternative source exists, "tie-in sales/' price 

differentials, and other creditor controls may occur. The discounting of 

receivables also is of much benefit to some small concerns that must carry 

their customers' accounts; many that do so, however, are excluded from 

this form of accommodation by lack of confidence in their credit policies 

on the part of financing concerns, and it was in this general field that the 

TNEC investigators in 1939-40 found instances of unduly high charges. 

Neither the mercantile credit nor the discount of receivables is subject 

to adequate legal regulation in some States, a situation that emphasizes 

the need of increased competition. 

Such competition can best be furnished by the commercial banks, in 

the form of cash credit. Banks have increasingly entered the small 

business working capital field, with results that have generally benefited 

the earning capacity of the clients. The charges are inevitably somewhat 

higher than the charges of a corresponding service to large concerns; 

the interest rate includes not only true interest, but also the unit cost of 

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handling and servicing the small transaction, plus a margin for protection 

against loss. Experience and system, however, can reduce the handling 

cost, while the proposed central guaranteeing fund, costing only the 

premium fee, would replace the loss coverage factor. More fundamentally, 

the guarantee, being tantamount to additional collateral, would enable 

loans to be made in higher ratios to the equity size, in which, as has been 

seen, the smaller businesses are characteristically deficient. The guarantee 

also would stabilize the short-term credit against discontinuance on 

the basis of temporary or cyclical fluctuations in business earnings. In 

this way it appears that the major needs of the small business working 

capital situation would be met by the establishment of a central fund for 

underwriting the working capital loans of banks. 

Application to Long-Term Capital Needs. It is often stated that the 

main requirement of the small business is a greater availability of "equity" 

or capital funds. But as to the method by which such funds should be 

raised confusion exists. Small businesses not infrequently have been 

advised to sell some portion of their ownerships in order to raise equity 

capital. Proposals have been made for solving the financing problem of 

small business by establishing a private or a Governmental investment 

corporation, to purchase and hold ownership shares in small business, 

usually with the privilege of reselling them. 

Such proposals appear untenable. The primary characteristic of small 

business, and the one best worth preserving, is its independence of ownership. The management of the great corporation usually does not care 

and seldom knows who has acquired stock in the corporation, unless the 

block be so large as to convey a concentration of control. But in the case 

of the small business, any sale of ownership conveys a considerable degree 

of control. Within the intimate and personal relationship among stockholders in the closely held or family corporation, or between partners in 

unincorporated small businesses, even a minority share has a voice, and a 

difference of opinion readily becomes dissension. 

The small business proprietor, if he has faith in his business, wants to 

retain the full profit of that which he has built, and also is aware of the 

dangers of dividing the control. The lack of a trading post for small 

business ownership shares thus is due not alone to lack of investor demand 

for the less well-known security, but to lack of supply from small business. 

If the independent proprietor sells a share in his business to a stranger, 

he assumes an unknown risk; personal considerations enter even in 

accepting a "silent partner/' experience having shown that such a partner 

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does not always remain silent. If he sells a share to a larger business, or to 

an investor associated therewith, the independent enterprise tends to 

become a subsidiary. If, as has been proposed, a private investment 

company were set up to buy small business equity shares, it would 

strongly resemble a small business holding company, a situation from 

which a new set of problems might conceivably arise. If the equity capital 

source were a Government agency the problems would be yet more 

fundamental, endangering the private enterprise character of the venture 

sector of the economy. 

These considerations are cogent ones. For small business to raise its 

needed capital by forfeiting its independent status would be to abolish 

that which it is primarily sought to preserve. It becomes necessary to 

regard the problem of supplying capital funds to small business as a problem in the field of term credit. A business debtor's independence is 

reduced during the life of the debt, but it is riot permanently sacrificed. 

Obstacles to the Term Loan. That commercial banks should become 

a source of term loans to small business is among the recommendations of 

the Postwar Small Business Credit Commission of the American Bankers 

Association. That the purposes of such term loans should include fixedcapital as well as working capital purposes is contemplated in a pamphlet 

circulated by the Commission.19 That these recommendations involve a 

departure from a long standing tradition in bank-credit practices is of 

less vital importance than the fact that practical obstacles exist. The 

difficulties of risk appraisal for small business credit purposes increase 

when the risk must be estimated in advance for a period of years. 

1. Available collateral is likely to be inadequate for a term loan. As 

the table on page 54 has shown, the typical small business has a relatively 

small amount of fixed assets in ratio to its volume of business. In terms 

of credit, this means that its ability to supply first-mortgage security 

in the form of land, buildings, and equipment is relatively limited. The 

fixed assets, moreover, often have a special purpose quality, reducing the 

ability of the creditor to recover the value in resale. Time increases the 

doubt as to such value. Some additional collateral and assurance of 

repayment in the distant future appear essential if term funds are to flow. 

2. The life prospect of the small business also is a credit risk. Various 

statistical samples have indicated that the life of the small business is 

much briefer than that of the large. Such statistics must, of course, be 

19 Association of Reserve City Bankers, Term Lending by Commercial Banks, pp. 4-6. 

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qualified; they often reflect changes in the proprietorships rather than in 

the actual business life, the fact in many cases being that proprietors 

come and go, while the business continues and previous debts are assumed. 

It remains true, nevertheless, that the small business is ordinarily reliant 

upon one man, its proprietor, and that the longevity of that man, and his 

continued association with the enterprise, are factors of doubt in term 

credit. 

3. The future of the restricted market upon which the small business 

rests is difficult to foresee over time. An enterprise selling to one or two 

business consumers may lose its entire market at a stroke. One that 

depends upon the consumers of a small town or a neighborhood is dependent on the continued purchasing power of that locality. 

4. Earnings of small business are likely to be highly fluctuant. Fixed 

charges for debt retirement therefore are likely to become delinquent 

at some time in the life of a term loan, and a considerable flexibility in 

retirement terms, even in interest payments, is necessary if foreclosure is 

to be avoided. This does not mean that the debt will not be retired in time. 

The Louisville Industrial Foundation, which abandoned the "straightline" payment schedule in favor of various graded payment plans, including sliding schedules, partial recapture of net profits, and liberal use of 

extensions and refinancings, has had repeated experiences of 10-year 

loans that dragged on for as much as 15 or 20 years, only to be retired 

successfully with interest paid in full in the end. Other loans were retired 

well ahead of time.20 Banking standards, derived from the more stable 

type of enterprise, must accommodate themselves to fluctuating business 

earnings and include flexible practices of loan retirement if small business 

is to be provided with term capital. 

5. The culminating obstacle, applying to all four of these considerations, is that the commercial banking system is composed of many unit 

banks and that most banks interested in small business are themselves 

relatively small. They must safeguard their liquidity, their individual 

credit capacities are limited, and in many cases the requisite appraisal 

technics and flexible practices for the term loan to a small business are 

unfamiliar in their experience. 

Central Guaranteeing of Term Loans. To the obstacles stated above, 

the central fund credit underwriting proposal emphatically applies. 

Indeed, without an insurance type protection behind the credit risks of 

20

 Or. cit., pp. 9-11, 39. 

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LONG-TERM NEEDS OF SMALL BUSINESS 75 

small banks, commercial banking cannot become the source of long- or 

medium-term capital loans for small business to anything approaching 

the required extent. 

The guarantee, which amounts to a cosigning of the note of the small 

business by the guaranteeing agency, provides what is in effect the necessary collateral. The risks of changes in ownership and of business discontinuance are cushioned by the insurance. So likewise are unforeseen 

changes in the market base; the existence of the guarantee enables the 

creditor to wait while market readjustments are being made. The insurance further provides a safeguard behind which the necessary experimentation in flexible retirement policies may occur. Since the stipulated 

portion of the credit can be transferred to the central fund at the bank's 

demand, liquidity can be regained at any time. All these features were fully 

demonstrated by the wartime loan guaranteeing experience of the 

Federal Reserve System under Regulation V. 

Some General Considerations. The central credit underwriting plan 

is not new. It was tested over an eight-year period prior to the Second 

World War under Section 13b of the Federal Reserve Act and Section 5d 

of the Reconstruction Finance Corporation Act. The culminating proof 

of its effectiveness occurred during the war, when 10.3 billion dollars in 

commercial loans to war producers were guaranteed through the agency 

of the Federal Reserve System, with a loss ratio of only 0.06 per cent. 

This was an exceptional situation, since the sales of war products were 

assured in advance provided they were up to standard; a higher loss ratio 

is doubtless to be anticipated under peacetime market conditions, especially if a depression should occur. To stabilize the access of small 

business to loan funds would, however, have an important effect in counteracting depression. 

The proposed underwriting of credits has been attacked in certain 

circles as tending to reduce the independence of judgment of the commercial banks. It is questionable whether the usage of any form of voluntary insurance can be validly attacked upon this ground. As in the other 

forms, 100 per cent protection of credit risks is not proposed, primarily 

for the reason that the judgment and responsibility of the lending institution must be retained as an essential feature of the plan. 

The Reconstruction Finance Corporation in its blanket guarantee 

plan provides that the lending institution shall retain at least 25 per cent 

of each risk exposure. The Board of Governors of the Federal Reserve 

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76 PRIVATE CAPITAL REQUIREMENTS 

ness Advisory Committee of the Department of Commerce have recommended that in individual cases the coverage may be as high as 90 per 

cent, in order to permit an adequate assumption of ventures and extension 

of the existing margins of commercial credit to new borrowers. To accomplish the main purpose of the plan, the coverage of risk must obviously at 

times be high; in the wartime experience under Regulation V, the over-all 

amount guaranteed was about 85 per cent, and more than half of all V 

loans carried a 90 per cent coverage against loss. With favorable experience, no doubt, the percentage of coverage would tend to decline. 

Much would depend in practice upon the administration of the underwriting fund. This should be liberal. If too selective, small business would 

remain inadequately financed; if recklessly administered, the fund would 

have an unduly high loss ratio and the premium rates would rise. The 

requirement that the lending institution retain a share in the exposure is 

in itself a protection against recklessness; indeed the more immediate 

danger is in the other direction, namely, that of a too great avoidance of 

economically desirable ventures. 

It is of the nature of insurance to extend its inclusion of risks as widely 

as possible in the interest of a large and diversified "pool." This conforms 

to the purpose of the plan. Finally, the necessity of experimentation and 

trial and error experience in venture financing is obvious. What is called 

for fundamentally is the revival of venture in institutional finance. If 

private enterprise in finance, especially commercial banking, does not 

solve the problems of financing small business, the pressure for the 

Government to do so will undoubtedly increase. The banking structure 

should include provision for a central underwriting of its small-business 

credit risks. 

SUMMARY AND CONCLUSION 

The small business sector is of fundamental importance to the economy, 

not only because large numbers of small enterprises perform a wide 

variety of detailed economic work, but also because of the need of preserving an area of individualism in business and retaining the essential place 

of venture enterprise in the economy. 

Through a half-century or more of increasing centralization, the small 

units have continued relatively as numerous as ever. Their place in total 

production today centers upon those numerous functions that are capable 

of small-unit performance. For these functions small business has flexible 

efficiency. The normal quota of business aids has, however, been lacking 

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LONG-TERM NEEDS OF SMALL BUSINESS 77 

and the business environment has been unfavorable to smallness for many 

years past. The effect of the "institutional gap" in business facilities, 

combined with the operative limitations of smallness, has been to restrict 

competition, reduce venturing, and place many small businesses in a dependent and ancillary position. 

The first line of attack upon this situation is to make available to the 

smaller units those nonfinancial business services that are readily available 

to the large organizations—informational, technological, advisory, and 

other managerial facilities—together with an increased protection against 

destructive practices in competition and in the bargaining relationships 

between small units and larger ones. 

The second main approach is financial, calling for adjustments in taxation to aid internal financing, for the provision of adequate access to external funds for small businesses, and for a greater equalization of the 

differentials in financial services among businesses according to size. 

Cheaper and more reliable working capital credits are needed. A yet more 

primary need is term credit for capital purposes. 

The problem of commercial banks and other lending institutions in providing such credit can be solved through a central underwriting fund behind their more uncertain credit risks. Such an underwriting fund should 

be set up in the established central banking agency of the commercial 

credit system as a permanent aid to small business. 

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